Bulletin No. 2023–50

Agency decision

Ask Donna

What actually matters in this document.

Text

HIGHLIGHTS

OF THIS ISSUE

Bulletin No. 2023–50

December 11, 2023

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

REG-131756-11, page 1386.

This document contains proposed regulations that would

update regulations regarding whether persons are treated

as related persons who are subject to certain special rules

pertaining to transactions with partnerships. The regulations

affect partnerships that enter into transactions with related

persons that result in gain or loss on a sale or exchange of

property or result in a difference in the time at which income

and deductions are recognized because of the persons’ different methods of accounting.

Finding Lists begin on page ii.

REG-132422-17, page 1390.

Taxpayers are required to recognize taxable income or loss

and foreign currency gain or loss with respect to a qualified

business unit that has a functional currency other than the

dollar. The proposed regulations would provide an election

to treat all items of a qualified business unit as marked items

(subject to a loss suspension rule), an election to recognize

all foreign currency gain or loss with respect to a qualified

business unit on an annual basis, a new transition rule, and

certain other rules. REG-132422-17. Published on November

14, 2023.

The IRS Mission

Provide America’s taxpayers top-quality service by helping

them understand and meet their tax responsibilities and

enforce the law with integrity and fairness to all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements of

internal practices and procedures that affect the rights and

duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service

on the application of the law to the pivotal facts stated in

the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature are

deleted to prevent unwarranted invasions of privacy and to

comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not have the

force and effect of Treasury Department Regulations, but they

may be used as precedents. Unpublished rulings will not be

relied on, used, or cited as precedents by Service personnel in

the disposition of other cases. In applying published rulings and

procedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be considered,

and Service personnel and others concerned are cautioned

against reaching the same conclusions in other cases unless

the facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions and Other Related Items, and Subpart B,

Legislation and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to these

subjects are contained in the other Parts and Subparts. Also

included in this part are Bank Secrecy Act Administrative

Rulings. Bank Secrecy Act Administrative Rulings are issued

by the Department of the Treasury’s Office of the Assistant

Secretary (Enforcement).

Part IV.—Items of General Interest.

This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative index

for the matters published during the preceding months. These

monthly indexes are cumulated on a semiannual basis, and are

published in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

December 11, 2023

Bulletin No. 2023–50

Part IV

Transactions Between

Related Persons and

Partnerships

REG-131756-11

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains

proposed regulations that would update

regulations regarding whether persons are

treated as related persons who are subject

to certain special rules pertaining to transactions with partnerships. The regulations

affect partnerships that enter into transactions with related persons that result in

gain or loss on a sale or exchange of property or result in a difference in the time

at which income and deductions are recognized because of the persons’ different

methods of accounting.

DATES: Written or electronic comments

and requests for a public hearing must be

received by February 26, 2024. Requests

for a public hearing must be submitted as prescribed in the “Comments and

Requests for a Public Hearing” section.

ADDRESSES: Commenters are strongly

encouraged to submit public comments

electronically. Submit electronic submissions via the Federal eRulemaking Portal

at https://www.regulations.gov (indicate

IRS and REG-131756-11). Once submitted to the Federal eRulemaking Portal,

comments cannot be edited or withdrawn.

The Department of Treasury (Treasury

Department) and the IRS will publish any

comments submitted electronically and

comments submitted on paper to the IRS’s

public docket. Send paper submissions

to: CC:PA:LPD:PR (REG-131756-11),

Room 5203, Internal Revenue Service,

P.O. Box 7604, Ben Franklin Station,

Washington, D.C. 20044.

FOR FURTHER INFORMATION

CONTACT: Concerning the proposed

regulations relating to section 267, Livia

December 11, 2023

Piccolo, (202) 317-7007 (not a toll-free

number); concerning the proposed regulation relating to section 707, Charles

D. Wien, (202) 317-5279 (not a toll-free

number); and concerning the submission

of comments and requests for a public

hearing, Vivian Hayes, (202) 317-6960

(not a toll-free number) or by sending

an email to publichearings@irs.gov

(preferred).

SUPPLEMENTARY

INFORMATION:

Background

This

document

contains

proposed amendments to the Income Tax

Regulations (26 CFR part 1) under sections 267 and 707 of the Internal Revenue

Code (Code) relating to the disallowance

or deferral of deductions for losses and

expenses in certain transactions with partnerships and related persons (proposed

regulations). The proposed regulations

would remove §1.267(b)-1(b) and amend

§1.267(a)-1 to remove the application

of Questions and Answers 2 and 3 in

§1.267(a)-2T(c) for taxable years ending

on or after the date the Treasury decision

adopting these regulations as final regulations is published in the Federal Register.

In addition, the proposed regulations

would amend §1.707-1(b).

In general, section 267(a)(1) provides

that a taxpayer may not deduct a loss on

the sale or exchange of property with a

related person as defined in section 267(b).

Section 267(a)(2) sets forth a “matching

rule” that provides that if because of a

payee’s method of accounting, an amount

is not (unless paid) includible in the payee’s gross income, the taxpayer (payor)

may not deduct the otherwise deductible amount until the payee includes the

amount in gross income if the taxpayer

and payee are related persons within the

meaning of section 267(b) on the last day

of the taxpayer’s taxable year in which

the amount otherwise would have been

deductible.

As part of enacting the Internal Revenue

Code of 1954, Public Law 83-591, ch.

736, 68A Stat. 1 (1954), Congress added

1386

section 707(b)(1) to the Code to address

the sale or exchange of property between a

partnership and a partner owning, directly

or indirectly, more than 50 percent of the

capital or profit interest in the partnership.

68A Stat. at 243. Given a lack of statutory and regulatory guidance addressing

transactions between a partnership and a

related person who was not a partner, the

Treasury Department and the IRS issued

§1.267(b)-1(b) in 1958. See TD 6312, 23

FR 7035 (Sep. 11, 1958).

Section 1.267(b)-1(b) applies an aggregate theory of partnerships to provide

that any transaction described in section

267(a) between a partnership and a person other than a partner is considered as

occurring between the other person and

the members of the partnership separately.

Specifically, §1.267(b)-1(b) provides that

if the other person and a partner are within

any of the relationships specified in section

267(b), no deductions with respect to the

transaction between the other person and

the partnership will be allowed: (i) to the

related partner to the extent of the related

partner’s distributive share of partnership

deductions for losses or unpaid expenses

or interest resulting from the transactions,

and (ii) to the other person to the extent

the related partner acquires an interest in

any property sold to or exchanged with the

partnership by the other person at a loss,

or to the extent of the related partner’s distributive share of the unpaid expenses or

interest payable to the partnership by the

other person as a result of the transaction.

The U.S. Tax Court upheld the validity

of §1.267(b)-1(b) and its use of the aggregate theory in Casel v. Commissioner, 79

T.C. 424 (1982). However, subsequent

statutory changes to sections 267 and

707(b) have made §1.267(b)-1(b) inconsistent with the statute.

In 1982, Congress enacted section 3(h)

(1) of the Subchapter S Revision Act of

1982, Public Law 97-354, 96 Stat. 1669,

1689 (1982) to add section 267(b)(10) to

the Code to disallow a deduction resulting from a transaction between a commonly-controlled partnership and an S

corporation. Specifically, section 267(b)

(10) provides that an S corporation and

a partnership were related persons if the

Bulletin No. 2023–50

same persons owned more than 50 percent

of the outstanding stock of the S corporation and more than 50 percent of the

capital interest or the profits interest in the

partnership.

In 1984, Congress enacted section

174(b)(1) of the Tax Reform Act of 1984

(TRA 1984), Public Law 98-369, 98 Stat.

494, 705 (1984), to add section 267(e) to

the Code generally to extend the matching rule of section 267(a)(2) to transactions between a partnership and a partner

or a person related to a partner (within

the meaning of sections 267(b) or 707(b)

(1)). Congress also enacted section 174(b)

(3) of the TRA 1984, 98 Stat. at 707, to

amend section 267(b)(10) to include C

corporations as well as S corporations.

In 1985, the Treasury Department and

the IRS issued §1.267(a)-2T(c) to provide

guidance for transactions between related

partnerships. Consistent with the legislative history of the TRA 1984, the regulations generally apply an aggregate theory

of partnerships in deferring deductions

according to the partners’ aggregate interests in the payor partnership. See S. Rep.

No. 98-169, 98th Cong., 2nd Sess., at 496

and n. 17 (1984); TD 7991, 49 FR 46992

(Nov. 30, 1984).

In the Tax Reform Act of 1986 (TRA

1986), Public Law 99-514, 100 Stat. 2085

(1986), Congress amended section 707(b)

in two ways. First, Congress revised sections 707(b)(1)(A) and 707(b)(2)(A) to

expand the application of those provisions to a person who is not a partner and

modified section 707(b)(2) to reduce the

thresholds described in that section from

more than 80 percent of profits or capital to more than 50 percent of profits or

capital for purposes of treating recognized

gain between related persons as ordinary

income. As amended by section 1812(c)

(3) of the TRA 1986, 100 Stat. at 2834, the

loss disallowance rules of section 707(b)

(1)(A) and the character of gain rules of

section 707(b)(2)(A) apply to transactions

between a partnership and any person (a

partner or non-partner) who directly or

indirectly owns more than 50 percent of

the capital or profits interest in the partnership. See sections 707(b)(1)(A), (b)(2)

(A), and (b)(3).

Second, in enacting section 642(a)

(2) of the TRA 1986, 100 Stat. at 2284,

Congress amended section 707(b)(1)(B)

Bulletin No. 2023–50

to provide that for purposes of the matching rule in section 267(a)(2), two partnerships in which the same persons own,

directly or indirectly, more than 50 percent of the capital interests or profits interests are treated as related persons within

the meaning of section 267(b). The related

committee reports state that the modifications to section 707(b), and in particular

to section 707(b)(1)(B), were intended

to replace Questions and Answers 2 and

3 of §1.267(a)-2T(c). See H. Rept. No.

99-426, 99th Cong., 1st Sess., at 940 and

n. 7 (1986), 1986-3 C.B. Vol. 2, at 940 and

n. 7; S. Rep. No. 99-313, 99th Cong., 2nd

Sess., at 960 and n. 7, 1986-3 C.B. Vol. 3,

959, 960 and n. 7.

Explanation of Provisions

The statutory changes to sections 267

and 707(b) enacted since 1982 indicate

that Congress intended for a partnership

to be viewed as an entity, rather than as

an aggregate of its partners, in applying the rules of sections 267 and 707(b).

Therefore, the loss disallowance rules

of sections 267(a)(1) and 707(b)(1), the

gain recharacterization rules of section

707(b)(2), and the matching rule of section 267(a)(2) similarly should be applied

at the partnership level and not the partner level. Accordingly, the rules relating

to partnerships in §1.267(b)-1(b) and

§1.267(a)-2T(c), Questions and Answers

2 and 3, do not conform to Congress’s

view of how section 267 should be applied

to partnerships.

To conform the regulations under section 267 with the current statute, the proposed regulations propose: (1) to remove

§1.267(b)-1(b), (2) to amend §1.267(a)-1

to reflect the rules in Questions and

Answers 1 and 4 in §1.267(a)-2T(c) as

§1.267(a)-1(d)(2) and (3); and (3) to

amend §1.267(a)-1 to terminate the application of Questions and Answers 2 and 3

in §1.267(a)-2T(c). The regulations under

§1.267(a)-2T(b), which provide questions and answers applying section 267(a)

(2) and (b) generally, would continue to

apply. The Treasury Department and IRS

are aware that some of the citations in the

existing regulations under section 267

may be outdated due to subsequent legislative and regulatory changes. However,

the rules in these questions and answers

1387

remain substantively accurate. For example, Question 1 under §1.267(a)-2T(b)

refers to the completed contract method

under §1.451-3(d). The substance of this

answer remains correct; however, the

correct citation to the completed contract method is now under §1.460-4(d).

Modifications to update incorrect citations

in §1.267(a)-2T(b) are outside the scope

of these proposed regulations. Finally,

these proposed regulations also revise

§1.707-1(b) to conform to the statutory

changes made to sections 267 and 707(b).

Proposed Applicability Date

These regulations are proposed to

apply to taxable years ending on or after

the date the Treasury decision adopting

these rules as final regulations is published in the Federal Register. Thus,

§1.267(b)-1(b) would be removed, and

the revisions to §1.267(a)-1 would apply

to taxable years ending on or after the

date the Treasury decision adopting these

rules as final regulations is published in

the Federal Register. Similarly, the revisions to §1.707-1(b) would apply to sales

or exchanges of property with respect to

controlled partnerships in taxable years

ending on or after the date the Treasury

decision adopting these rules as final

regulations is published in the Federal

Special Analyses

I. Regulatory Impact Analysis

Pursuant to the Memorandum

of Agreement, Review of Treasury

Regulations under Executive Order 12866

(June 9, 2023), tax regulatory actions

issued by the IRS are not subject to the

requirements of section 6 of Executive

Order 12866, as amended. Therefore,

a regulatory impact assessment is not

required.

II. Paperwork Reduction Act

These proposed regulations do not

impose any additional information collection requirements in the form of reporting,

recordkeeping requirements, or thirdparty disclosure statements. However,

a taxpayer may continue to be required

December 11, 2023

to report on Form 1065, U.S. Return of

Partnership Income, information about

partners that own directly or indirectly

more than 50 percent of the partnership.

Data on the number of affected taxpayers

is not available.

For purposes of the Paperwork

Reduction Act of 1995 (44 U.S.C.

3507(c)) (PRA), the reporting burden

associated with the collection of information for Form 1065 will be reflected in

the PRA submission associated with the

income tax returns under the OMB control

number 1545-0123.

The overall burden estimates associated with the OMB control number 15450123 is an aggregate number related to

the entire package of forms associated

with the applicable OMB control number

and will include, but not isolate, the estimated burden of the tax forms that will

be created or revised as a result of these

proposed regulations. These numbers

are therefore not specific to any burden

imposed by these proposed regulations.

The burdens have been reported for other

income tax regulations that rely on the

same information collections and the

Treasury Department and the IRS urge

readers to recognize that these numbers

are duplicates and to guard against overcounting the burdens imposed by tax

provisions prior to the Act. No burden

estimates specific to the forms affected

by the proposed regulations are currently

available. For the OMB control numbers

discussed in this paragraph, the Treasury

Department and the IRS estimate PRA

burdens on a taxpayer-type-basis rather

than a provision-specific basis. Those

estimates capture both changes made by

the Act and those that arise out of discretionary authority exercised in the proposed regulations (when final) and other

regulations that affect the compliance

burden for that form.

The Treasury Department and the IRS

request comments on all aspects of information collection burdens related to the

proposed regulations, including estimates

for how much time it would take to comply with the paperwork burdens described

above for each relevant form and ways

for the IRS to minimize paperwork burden. In addition, when available, drafts

of IRS forms are posted for comment

https://appsirs.gov/app/pickleist/lit/

December 11, 2023

draftTaxForms.htm. IRS forms are available at https://www.irs.gov/forms-instructions. Forms will not be finalized until

after they have been approved by OMB

under the PRA.

does this rule include any Federal mandate that may exceed the threshold for the

private sector.

III. Regulatory Flexibility Act

Executive Order 13132 (Federalism)

prohibits an agency from publishing any

rule that has federalism implications if

the rule either imposes substantial, direct

compliance costs on State and local governments, and is not required by statute,

or preempts State law, unless the agency

meets the consultation and funding

requirements of section 6 of the Executive

Order. This proposed rule does not have

federalism implications and does not

impose substantial, direct compliance

costs on State and local governments or

preempt State law within the meaning of

the Executive Order.

The Regulatory Flexibility Act (5

U.S.C. 601 et seq.) (RFA) imposes certain requirements with respect to Federal

rules that are subject to the notice and

comment requirements of section 553(b)

of the Administrative Procedure Act (5

U.S.C. 551 et seq.) and that are likely to

have a significant economic impact on a

substantial number of small entities. The

Treasury Department and the IRS certify

that this proposal will not have a significant economic impact on a substantial

number of small entities. The proposed

regulations would remove certain outdated regulations under section 267 that

apply an aggregate theory of partnerships and relocate other regulations that

are not intended to be obsoleted. These

regulations would preserve the status quo

by updating the existing regulations to

reflect the currently effective statutory

provisions. Accordingly, this proposal is

unlikely to have a significant economic

impact on any small entities affected.

The Treasury Department and the IRS

invite comments on the impact on small

entities.

Pursuant to section 7805(f) of the

Code, this notice of proposed rulemaking

has been submitted to the Chief Counsel

of the Office of Advocacy of the Small

Business Administration for comment on

its impact on small business.

IV. Unfunded Mandates Reform Act

Section 202 of the Unfunded Mandates

Reform Act of 1995 (UMRA) requires

that agencies assess anticipated costs and

benefits and take certain other actions

before issuing a final rule that includes any

Federal mandate that may result in expenditures in any one year by a State, local, or

Tribal government, in the aggregate, or by

the private sector, of $100 million in 1995

dollars, updated annually for inflation.

This rule does not include any Federal

mandate that may result in expenditures

by State, local, or Tribal governments, nor

1388

V. Executive Order 13132: Federalism

Comments and Requests for a Public

Hearing

Consideration will be given to comments that are submitted timely to the IRS

as prescribed in the preamble under the

“ADDRESSES” section. The Treasury

Department and the IRS request comments on all aspects of the proposed

regulations. Any electronic and paper

comments submitted will be available

at https://www.regulations.gov or upon

request. A public hearing will be scheduled if requested in writing by any person

that timely submits written comments. If

a public hearing is scheduled, notice of

the date, time, and place for the public

hearing will be published in the Federal

that public hearings will be conducted in

person, although the IRS will continue to

provide a telephonic option for individuals who wish to attend or testify at a hearing by telephone. Any telephonic hearing

will be made accessible to people with

disabilities.

Drafting Information

The principal author of these proposed

regulations is Livia Piccolo of the Office

of Associate Chief Counsel (Income Tax

and Accounting). However, other personnel from the Treasury Department and the

Bulletin No. 2023–50

IRS participated in the development of the

regulations.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the

Regulations

Accordingly, the Treasury Department

and the IRS propose to amend 26 CFR

part 1 as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

*****

Par. 2. Section 1.267(a)-1 is amended

by adding new paragraphs (d) and (e) to

read as follows:

§1.267(a)-1 Deductions disallowed.

*****

(d) Rules for partnerships under the

Tax Reform Act of 1984—(1) In general.

Paragraphs (d)(2) and (d)(3) of this section provide rules under section 267(a)

and related provisions, as amended by section 174 of the Tax Reform Act of 1984,

Public Law 98-369, 98 Stat. 494, 705

(1984), applicable specifically to partnerships for taxable years ending on or after

[DATE OF PUBLICATION OF FINAL

RULE IN THE FEDERAL REGISTER].

Section 1.267(a)-2T(c) does not apply to

taxable years ending on or after [DATE

OF PUBLICATION OF FINAL RULE

IN THE FEDERAL REGISTER].

(2) Application of section 267(a) to disallow losses and defer otherwise deductible amounts at the partnership (entity)

level. If a loss realized by a partnership

from a sale or exchange of property is

disallowed under section 267(a)(1), that

loss does not enter into the computation

of the partnership’s taxable income. If an

amount that otherwise would be deductible by a partnership is deferred by section 267(a)(2), that amount does not enter

into the computation of the partnership’s

taxable income until the taxable year

of the partnership in which falls the day

Bulletin No. 2023–50

on which the amount is includible in the

gross income of the person to whom payment of the amount is made.

(3) Application of section 267(e)(5)

(C)(ii). The phrase incurred at an annual

rate not in excess of 12 percent in section 267(e)(5)(C)(ii) refers to interest that

accrues but is not includible in the income

of the person to whom payment is to be

made during the taxable year of the payor.

Thus, in determining whether the requirements of section 267(e)(5) (providing an

exception to certain provisions of section

267 for certain expenses and interest of

partnerships owning low income housing) are met with respect to a transaction,

the requirement of section 267(e)(5)(C)

(ii) will be satisfied, even though the total

interest (both stated and unstated) paid or

accrued in any taxable year of the payor

taxpayer exceeds 12 percent, if the interest

in excess of 12 percent per annum, compounded semi-annually, on the outstanding loan balance (principal and accrued

but unpaid interest) is includible in the

income of the person to whom payment is

to be made no later than the last day of

such taxable year of the payor taxpayer.

(e) Applicability date. Paragraph (d) of

this section applies to taxable years ending

on or after [DATE OF PUBLICATION

OF FINAL RULE IN THE FEDERAL

Par. 3. Section 1.267(b)-1 is amended

by revising paragraph (b) to read as

follows:

§ 1.267(b)-1. Relationships.

*****

(b) Applicability date. This section

applies to taxable years ending on or after

[DATE OF PUBLICATION OF FINAL

RULE IN THE FEDERAL REGISTER].

Par. 4. Section 1.707-1 is amended by:

1. Removing the language “partner” in

paragraph (b)(1)(i) and adding the

language “person” in its place;

2. Removing the language “the provisions of subdivision (i) of this subparagraph,” in paragraph (b)(1)(ii)

and adding the language “paragraph

(b)(1)(i) of this section,” in its place;

3. Adding new paragraph (b)(1)(iii);

4. Removing the language “partner” in

paragraph (b)(2) and adding the language “person” in its place;

1389

Removing the language “80 percent”

in the first and second sentences of

paragraph (b)(2) and adding the language “50 percent” in its place; and

6. Revising paragraph (b)(3).

The additions and revision read as

follows:

§1.707-1 Transactions between partner

and partnership.

*****

(b) * * *

(1) * * *

(iii) For purposes of matching deductions and income in the case of expenses

and interest under section 267(a)(2), two

partnerships in which the same persons

own, directly or indirectly, more than 50

percent of the capital interests or profits

interests in each partnership will be treated

as persons specified in section 267(b).

*****

(3) Ownership of a capital or profits interest. For the purpose of applying

section 707(b), the rules for constructive

ownership of stock provided in section

267(c)(1), (2), (4), and (5) apply in determining the extent to which a capital interest or profits interest in a partnership is

owned, directly or indirectly, by any person, including a person who does not own

a partnership interest prior to application

of 267(c). For example, where trust T is a

partner in the partnership ABT, and AW,

A’s wife, is the sole beneficiary of the

trust, the ownership of a capital and profits interest in the partnership by T will be

attributed to AW both for the purpose of

further attributing the ownership of such

interest to A and for determining whether

AW is a constructive owner of an interest

in the partnership. See section 267(c) (1),

(2), and (5). Accordingly, if A, B, and T

are equal partners in ABT, because AW

is treated as constructively owning the

one-third capital and profits interest in

ABT owned by T and AW’s ownership

is attributed to A, A will be considered

as owning a more than 50 percent capital and profits interest in ABT, and a loss

sustained by A on a sale or exchange of

property with ABT will be disallowed by

section 707(b)(1)(A). Similarly, because

AW is treated as constructively owning

the one-third capital and profits interest in ABT owned by T and is attributed

December 11, 2023

the ownership of A’s capital and profits

interest in ABT, AW will be considered

as owning a more than 50 percent capital and profits interest in ABT and a loss

sustained by AW on a sale or exchange of

property with ABT would also be disallowed by section 707(b)(1)(A).

*****

Par. 5. Section 1.707-9 is amended by:

1. Revising the section heading;

2. Redesignating paragraphs (a) and (b)

as paragraphs (b) and (c); and

3. Adding new paragraph (a).

The addition and revision read as

follows:

§1.707-9. Applicability dates and

transitional rules.

(a) Section 1.707-1. Paragraphs (b)

(1)(i) through (iii), (b)(2), and (b)(3) of

§1.707-1 apply to sales or exchanges of

property with respect to controlled partnerships in taxable years ending on or after

[DATE OF PUBLICATION OF FINAL

RULE IN THE FEDERAL REGISTER].

*****

Douglas W. O’Donnell,

Deputy Commissioner for Services and

Enforcement.

(Filed by the Office of the Federal Register

November 24, 2023, 8:45 a.m., and published in the

issue of the Federal Register for November 27, 2023,

88 FR 82792)

Income and Currency Gain

or Loss with Respect to a

Qualified Business Unit

REG-132422-17

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking and partial withdrawal of notice of

proposed rulemaking.

SUMMARY: This document contains

proposed regulations relating to the determination of taxable income or loss and

foreign currency gain or loss with respect

December 11, 2023

to a qualified business unit. These proposed regulations include an election to

treat all items of a qualified business unit

as marked items (subject to a loss suspension rule), an election to recognize all foreign currency gain or loss with respect to a

qualified business unit on an annual basis,

and a new transition rule.

DATES: Written or electronic comments

and requests for a public hearing must be

received by February 12, 2024.

ADDRESSES: Commenters are strongly

encouraged to submit public comments

electronically via the Federal eRulemaking Portal at https://www.regulations.gov

(indicate IRS and REG-132422-17) by

following the online instructions for submitting comments. Requests for a public

hearing must be submitted as prescribed

in the “Comments and Requests for a

Public Hearing” section. Once submitted

to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The

Department of the Treasury (Treasury

Department) and the IRS will publish for

public availability any comments submitted to the IRS’s public docket. Send

paper submissions to: CC:PA:01:PR

(REG-132422-17), Room 5203, Internal

Revenue Service, P.O. Box 7604, Ben

Franklin Station, Washington, DC 20044.

FOR FURTHER INFORMATION

CONTACT: Concerning the proposed

regulations generally, Raphael J. Cohen at

(202) 317-6938; concerning consolidated

groups, Jeremy Aron-Dine at (202) 3176847; concerning submissions of comments, requests for a public hearing, and

access to a public hearing, Vivian Hayes

at (202) 317-5306 (not toll-free numbers)

or by e-mail to publichearings@irs.gov

(preferred).

SUPPLEMENTARY INFORMATION:

Background

I. Overview

This document contains proposed regulations (the “proposed regulations”) under

section 987 and related provisions under

sections 861, 985 through 989, and 1502

of the Internal Revenue Code (“Code”).

1390

Section 987 applies to any taxpayer that

has a qualified business unit (“QBU”)

with a functional currency other than the

dollar. Section 987(1) and (2) provide

rules for determining and translating taxable income or loss (“section 987 taxable income or loss”) with respect to the

QBU. In addition, foreign currency gain

or loss must be determined under section

987(3) (“section 987 gain or loss”), which

requires proper adjustments (as prescribed

by the Secretary) for transfers of property

between QBUs of the taxpayer having

different functional currencies. Section

989(c) authorizes the Secretary to prescribe necessary and appropriate regulations, including regulations limiting the

recognition of foreign currency loss on

certain remittances from QBUs.

II. Regulations Addressing the

Application of Section 987

A. 1991 proposed regulations and Notice

2000-20

On September 25, 1991, the Treasury

Department and the IRS published in

the Federal Register proposed regulations under section 987 (56 FR 48457,

September 25, 1991) (“1991 proposed

regulations”). The 1991 proposed regulations provided that section 987 taxable

income or loss is computed in the QBU’s

functional currency and is translated into

the taxpayer’s functional currency at the

weighted average exchange rate for the

taxable year. For purposes of determining section 987 gain or loss, taxpayers

were required to maintain an equity pool

in the QBU’s functional currency and

a basis pool in the taxpayer’s functional

currency. The equity and basis pools were

increased by the QBU’s earnings and by

capital contributed to the QBU, and they

were reduced by remittances, losses, and

other transfers from the QBU. Taxpayers

recognized section 987 gain or loss at the

time of a remittance or upon a termination

of the QBU. The amount of section 987

gain or loss recognized was equal to the

difference between the value of the remittance in the taxpayer’s functional currency

(translated at the applicable spot rate) and

the portion of the basis pool attributable to

the remittance. Thus, under the 1991 proposed regulations, section 987 gain or loss

Bulletin No. 2023–50

was determined by reference to a taxpayer’s entire equity interest in a QBU. The

1991 proposed regulations reserved on the

treatment of partnerships.

On April 3, 2000, the Treasury

Department and the IRS issued Notice

2000-20, 2000-1 C.B. 851. The Notice

expressed concern that the 1991 proposed

regulations may not have achieved their

goal of providing administrable rules that

result in foreign currency gain and loss

recognition under the appropriate circumstances. The Notice also identified certain

abusive transactions that could inappropriately accelerate recognition of section 987

loss under the 1991 proposed regulations.

B. 2006 proposed regulations

1. Concerns Relating to the 1991

Proposed Regulations

On September 7, 2006, the Treasury

Department and the IRS withdrew the

1991 proposed regulations and published

in the Federal Register new proposed

regulations under section 987 (71 FR

52876, September 7, 2006) (“2006 proposed regulations”). The preamble to

the 2006 proposed regulations explained

that the IRS had identified many cases in

which taxpayers inappropriately claimed

substantial section 987 losses resulting

from the application of the 1991 proposed

regulations when a QBU’s functional

currency depreciated relative to the functional currency of its owner. The 1991

proposed regulations also could create a

“trap for the unwary” by requiring recognition of large section 987 gains when a

QBU’s functional currency appreciated.

These results arose because the 1991

proposed regulations imputed section 987

gain or loss to all assets and liabilities of

a QBU, regardless of whether those assets

and liabilities were economically exposed

to currency fluctuations or had been subject to a realization event, and because the

1991 proposed regulations did not limit

the selective recognition of section 987

losses. Consequently, under the 1991 proposed regulations, exchange rate fluctuations that, at most, had only an uncertain

and remote effect on the economic results

experienced by the owner of a QBU could

give rise to substantial section 987 gains

and losses that taxpayers could selectively

Bulletin No. 2023–50

recognize by strategically timing remittances or causing a termination of the

QBU. For example, the 1991 proposed

regulations provided taxpayers with substantial flexibility to recognize section 987

losses selectively by causing QBUs with a

weak functional currency to make remittances while avoiding remittances from

QBUs with a strong functional currency

that would give rise to gains.

2. Foreign Exchange Exposure Pool

Method

To address the concerns relating to the

1991 proposed regulations, the 2006 proposed regulations provided a new method

of applying section 987, referred to as the

foreign exchange exposure pool (“FEEP”)

method. Under the FEEP method, the

owner of a QBU that is subject to section

987 (“section 987 QBU”) determines all

items of income, gain, deduction, and

loss attributable to the QBU in the QBU’s

functional currency, and then translates

those items into the owner’s functional

currency. For this purpose, the basis of certain assets (referred to as “historic assets”)

is translated at the exchange rate for the

date on which the asset was acquired (the

“historic rate”). For example, cost recovery deductions, such as depreciation, in

respect of historic assets are translated at

the historic rate. Other items (including

the amount realized on a sale or exchange

of a historic asset) are translated into the

owner’s functional currency at the average exchange rate for the taxable year.

In addition, the owner of a section 987

QBU must determine the pool of unrecognized section 987 gain or loss (“net unrecognized section 987 gain or loss”) based

on the annual increase or decrease to the

section 987 QBU’s balance sheet that

is attributable to foreign exchange rate

fluctuations. The amount of section 987

gain or loss that is added to the pool each

year is equal to the increase or decrease

in the basis of assets (net of the amount

of liabilities) of the section 987 QBU,

measured in the owner’s functional currency and adjusted for transfers between

the section 987 QBU and its owner and

section 987 taxable income or loss. See

§1.987-4(d) of the 2006 proposed regulations. For this purpose, certain assets and

liabilities (referred to as “historic items”)

1391

are translated into the owner’s functional

currency at the historic rate, while others

(referred to as “marked items”) are translated into the owner’s functional currency

at the applicable spot rate. As a result,

when translated into the owner’s functional currency, the balance sheet value of

marked items fluctuates when the QBU’s

functional currency strengthens or weakens, but the balance sheet value of historic

items does not.

Marked items and historic items are

defined by reference to section 988. A

marked item is an asset or liability that

would generate gain or loss under section

988 if it were held or entered into directly

by the owner of the section 987 QBU

but is not a section 988 transaction with

respect to the QBU itself. A historic item

is an asset or liability that is not a marked

item. Thus, under the FEEP method, section 987 gain or loss reflects currency

fluctuations with respect to marked items,

which would be subject to section 988

in the hands of the QBU’s owner. By

contrast, section 987 gain or loss is not

imputed to historic items that are not subject to section 988.

As a result of the use of a balance sheet

approach, together with the use of historic

rates for historic items, the FEEP method

distinguishes between those items whose

value is highly correlated with exchange

rates and those items for which exchange

rate fluctuations have no effect on value,

or only an uncertain or remote effect that

is more appropriately recognized upon a

realization event with respect to that item.

Unlike the 1991 proposed regulations,

which imputed section 987 gain or loss to

all assets and liabilities of a QBU, section

987 gain or loss under the FEEP method

relates to those assets and liabilities that

are economically exposed to currency

fluctuations. The FEEP method also minimizes a taxpayer’s ability to recognize

large section 987 losses unrelated to its

economic exposure and, thus, the need for

a limitation on the selective recognition of

such losses.

3. Partnerships

The 2006 proposed regulations applied

section 987 to partnerships using an aggregate approach. Under this approach, an

individual or corporation that is a partner

December 11, 2023

in a partnership is treated as an indirect

owner of a portion of the assets and liabilities of the partnership for purposes of

section 987. If the partner indirectly owns

a QBU with a functional currency different from that of the partner, the QBU is a

section 987 QBU, and the partner determines and recognizes section 987 gain or

loss with respect to the section 987 QBU

under the FEEP method. An elective de

minimis exception was provided for partners with a less than five percent interest

in a partnership.

4. Transition Rules

The 2006 proposed regulations provided two alternative methods for taxpayers to transition from their prior method of

applying section 987: the “deferral transition method” and the “fresh start transition

method.” Under both transition methods,

all the taxpayer’s section 987 QBUs were

deemed to terminate on the day before the

transition date, and the owner was treated

as having transferred each section 987

QBU’s assets and liabilities to a new section 987 QBU on the transition date. The

transition date was defined as the first day

of the first taxable year to which the 2006

proposed regulations apply to a taxpayer.

Under the deferral transition method,

section 987 gain or loss determined on the

date of the deemed termination (under the

taxpayer’s prior method) was treated as

net unrecognized section 987 gain or loss

of the new section 987 QBU, which could

be recognized on a remittance (or termination) in subsequent taxable years. The

assets and liabilities that were deemed

transferred to the section 987 QBU on the

transition date (including marked assets

and liabilities) were translated using historic rates, increased or decreased to take

into account any amount treated as net

unrecognized section 987 gain or loss

determined with respect to the deemed

termination. The deferral transition

method thus preserved the taxpayer’s section 987 gain or loss computed under its

prior method and adjusted the applicable

exchange rates to avoid double counting.

Under the fresh start transition method,

section 987 gain or loss that would have

been recognized under the taxpayer’s

prior method as a result of the deemed

termination was neither recognized nor

December 11, 2023

carried forward as net unrecognized section 987 gain or loss. The assets and liabilities that were deemed transferred to the

section 987 QBU on the transition date

(including marked assets and liabilities)

were translated using historic rates without adjustment.

The fresh start transition method

was designed to prevent recognition of

non-economic section 987 gain or loss

that was not recognized before the transition date. Because marked assets and

liabilities were translated at historic rates

under the fresh start transition method, any

section 987 gain or loss inherent in those

assets and liabilities would be added to

the pool of net unrecognized section 987

gain or loss in the taxable year beginning

on the transition date. However, exchange

rate fluctuations with respect to historic

items would not give rise to section 987

gain or loss. In addition, section 987 gain

or loss attributable to items that were no

longer reflected on the section 987 QBU’s

balance sheet on the transition date (for

example, assets that had been sold before

the transition date) would never be taken

into account.

Only taxpayers that were applying section 987(3) using a reasonable method

before the transition date were permitted

to use the deferral transition method. A

taxpayer whose prior method was unreasonable, or that failed to make required

determinations under section 987 in prior

years, was required to use the fresh start

transition method.

For this purpose, the preamble to the

2006 proposed regulations explained that

the method of applying section 987 provided in the 1991 proposed regulations

would be treated as a reasonable method.

The preamble to the 2006 proposed regulations further stated that the use of an

“earnings only” method would be treated

as a reasonable method. Under an “earnings only” method, section 987 gain or

loss is recognized on a distribution out of a

QBU’s earnings, but not on a distribution

in excess of earnings (which represents a

return of capital).

C. 2016 final regulations

On December 8, 2016, the Treasury

Department and the IRS published final

regulations (TD 9794) in the Federal

1392

2016) (the “2016 final regulations”). The

2016 final regulations largely adopt the

FEEP method contained in the 2006 proposed regulations but modify those regulations to make the FEEP method easier

for the IRS to administer and for taxpayers

to apply. For example, the 2016 final regulations permit taxpayers to use the yearly

average exchange rate as the historic rate

applicable to historic items. See §1.9873(c)(3). The 2016 final regulations also

modify the computation of net unrecognized section 987 gain or loss for a taxable

year by requiring adjustments for nondeductible expenses and tax-exempt income.

See §1.987-4(d)(7) and (8).

The 2016 final regulations maintain the

aggregate approach of the 2006 proposed

regulations for partnerships. However,

in response to comments relating to the

complexity of the aggregate approach, the

2016 final regulations apply only to partnerships that are wholly owned by related

persons (“section 987 aggregate partnerships”). The preamble to the 2016 final

regulations indicated that the treatment

of other partnerships under section 987

would be addressed separately and such

partnerships might be subject to a different approach.

The 2016 final regulations require taxpayers to transition using the fresh start

transition method. See §1.987-10. The

Treasury Department and the IRS were

concerned that an election between two

transition methods (as permitted under the

2006 proposed regulations) would result

in a whipsaw to the fisc, because each

taxpayer could choose the method that

produces more section 987 loss and less

section 987 gain (as was noted by comments on the 2006 proposed regulations).

The Treasury Department and the IRS

were also concerned about administrative

difficulties and planning opportunities

associated with adjustments to the translation rate under the deferral transition

method.

Section 1.987-11(a) provides that the

2016 final regulations generally apply to

taxable years beginning on or after one

year after the first day of the first taxable year following December 7, 2016.

However, taxpayers could choose to

apply them to an earlier taxable year under

§1.987-11(b).

Bulletin No. 2023–50

D. 2016 temporary and proposed

regulations

On December 8, 2016, the Treasury

Department and the IRS published

Treasury Decision 9795 (the “temporary

regulations”) in the Federal Register

(81 FR 88854, December 8, 2016) and

published a notice of proposed rulemaking (81 FR 88882, December 8, 2016)

(the “2016 proposed regulations”) in the

Federal Register by cross-reference to

the temporary regulations. The temporary

regulations (other than §1.987-12T) had

the same applicability date as the 2016

final regulations.

The temporary regulations and the

2016 proposed regulations include: (1)

rules relating to the recognition and deferral of section 987 gain or loss in connection with certain QBU terminations

and certain other transactions involving

partnerships; (2) an annual deemed termination election; (3) an elective method,

available to taxpayers that make the

annual deemed termination election, for

translating all items of income or loss with

respect to a section 987 QBU at the yearly

average exchange rate; (4) rules regarding

the treatment of section 988 transactions

of a section 987 QBU; (5) rules regarding

QBUs with the U.S. dollar as their functional currency; (6) rules regarding combinations and separations of section 987

QBUs; (7) rules regarding the translation

of income used to pay creditable foreign

income taxes; (8) rules regarding the allocation of assets and liabilities of certain

partnerships for purposes of section 987;

and (9) rules requiring the deferral of

certain section 988 loss that arises with

respect to related-party loans.

Under the annual deemed termination

election provided in the temporary regulations, a taxpayer could elect to deem all

of its section 987 QBUs to terminate on

the last day of each taxable year, resulting

in the recognition of all net unrecognized

section 987 gain or loss on an annual

basis. See §1.987-8T(d). The assets and

liabilities of a section 987 QBU subject to

the election were deemed to be distributed

to the owner pursuant to the deemed termination on the last day of each taxable

year and recontributed on the first day of

the following taxable year. The temporary regulations further provided that a

Bulletin No. 2023–50

taxpayer who made an annual deemed termination election could elect to translate

all items of section 987 taxable income or

loss at the yearly average exchange rate.

See §1.987-3T(d).

The temporary regulations (other than

those finalized or withdrawn in 2019, as

described in part II.E of this Background

section) expired on December 6, 2019.

The Treasury Department and the IRS

intend to remove the temporary regulations from the Federal Register when the

proposed regulations are finalized.

The following parts of the 2016 proposed regulations remain outstanding: (1)

rules regarding the treatment of section

988 transactions of a section 987 QBU

(see §§1.987-1, 1.987-3, and 1.988-1 of

the 2016 proposed regulations); (2) rules

regarding QBUs with the U.S. dollar as

their functional currency (see §§1.987-1

and 1.987-6 of the 2016 proposed regulations); (3) rules regarding the translation

of income used to pay creditable foreign

income taxes (see §1.987-3 of the 2016 proposed regulations); and (4) rules requiring

the deferral of certain section 988 loss that

arises with respect to related-party loans

(see §1.988-2 of the 2016 proposed regulations). A notice reopening the comment

period for the parts of the 2016 proposed

regulations that remain outstanding is published in this issue of the Federal Register.

E. 2019 final regulations

On May 13, 2019, the Treasury

Department and the IRS published

Treasury Decision 9857 (84 FR 20790,

May 13, 2019) (the “2019 final regulations” and, collectively with the 2016

final regulations, the “final regulations”)

in the Federal Register. The 2019 final

regulations finalized parts of the 2016

proposed regulations relating to combinations and separations of section 987

QBUs and the recognition and deferral

of section 987 gain or loss in connection

with certain QBU terminations and certain

other transactions involving partnerships.

The 2019 final regulations also withdrew

§1.987-7T of the temporary regulations,

relating to the allocation of assets and liabilities of a section 987 aggregate partnership to its partners for purposes of section

987, in response to comments noting that

these rules could cause distortions in the

1393

computation of section 987 gain or loss.

The 2019 final regulations (other than

§1.987-12) have the same applicability

date as the 2016 final regulations.

III. Executive Order 13789 and Interim

Report to the President

Executive Order 13789, issued on

April 21, 2017, instructs the Secretary of

the Treasury (the “Secretary”) to review

all significant tax regulations issued on or

after January 1, 2016, and to take action

to mitigate the burden of regulations that,

in relevant part, impose an undue financial burden on U.S. taxpayers or add

undue complexity to the Federal tax laws.

The Executive order further instructs the

Secretary to submit two reports to the

President: an interim report that identifies

regulations that meet the criteria described

in the Executive order; and a report that

recommends specific actions to mitigate

the burden imposed by regulations identified in the interim report.

In an interim report to the President

dated June 22, 2017, the Treasury

Department identified eight regulations,

including the 2016 final regulations,

as meeting at least one of the criteria

described in the Executive order. In Notice

2017-38, 2017-30 I.R.B. 147, which was

published on July 24, 2017, the Treasury

Department and the IRS requested comments on whether the regulations identified in the interim report (including the

2016 final regulations) should be rescinded

or modified and, if not rescinded, how the

regulations should be modified to reduce

the burden and complexity.

The Treasury Department and the IRS

received several comments in response

to Notice 2017-38. In addition, one comment was submitted in response to Notice

2017-57, 2017-42 I.R.B. 325 (which was

the first of the deferral notices described

in part V of this Background section).

The comments that are relevant to the

proposed regulations are discussed in the

Explanation of Provisions.

IV. Second Report to the President on

Identifying and Reducing Tax Regulatory

Burdens

On October 16, 2017, the Secretary

published a report (the “Report”) in the

December 11, 2023

Federal Register (82 FR 48013, October

16, 2017) recommending specific actions

to mitigate the burden imposed by the regulations identified in the interim report.

The Report stated that the Treasury

Department and the IRS intend to propose

modifications to the 2016 final regulations

and to issue guidance permitting taxpayers to elect to defer the application of

§§1.987-1 through 1.987-10.

In particular, the Report stated that,

in response to comments, the Treasury

Department and the IRS intend to propose

rules that would permit taxpayers to elect

to adopt a simplified method of calculating section 987 gain or loss and translating

section 987 taxable income or loss, subject

to certain limitations on the recognition of

section 987 loss. One simplified method

discussed in the Report would allow a taxpayer to treat all assets and liabilities of a

section 987 QBU as marked items and to

translate all items of income and expense

at the average exchange rate for the taxable year. Under this method, the amount

of section 987 gain or loss would generally

be consistent with the amount determined

under the 1991 proposed regulations and

would more closely conform to the applicable financial accounting rules.

The Report also noted that the Treasury

Department and the IRS were considering

limitations on the recognition of section

987 loss that would apply to taxpayers

using the simplified method. Two potential limitations were mentioned in the

Report: (1) a rule that would allow the

electing taxpayer to recognize net section

987 loss only to the extent of net section

987 gain recognized in prior or subsequent

years; and (2) a rule that would defer the

recognition of all section 987 gain or loss

until the earlier of (i) the year that the

trade or business conducted by the section

987 QBU ceases to be performed by any

member of its controlled group or (ii) the

year that substantially all of the assets and

activities of the QBU are transferred outside of the controlled group.

Finally, the Report stated that the

Treasury Department and the IRS were

considering alternative transition rules.

One alternative would allow taxpayers

to carry forward unrealized section 987

gains and losses (measured on the transition date with appropriate adjustments),

and a second alternative would allow taxpayers to translate all items of the section

987 QBU at the spot rate on the transition

date without carrying forward any unrecognized section 987 gain or loss.

V. Deferral Notices

The Treasury Department and the IRS

have issued several notices stating that

future guidance would defer the applicability dates of the 2016 final regulations,

§§1.987-2(c)(9) and 1.987-4(c)(2) and (f)

of the 2019 final regulations (the “related

2019 final regulations”), and §§1.987-1T

(other than §§1.987-1T(g)(2)(i)(B) and

(g)(3)(i)(H)) through 1.987-4T, 1.987-6T,

1.987-7T, 1.988-1T, and 1.988-2T(i) of

the temporary regulations. Most recently,

on August 22, 2022, Notice 2022-34,

2022-34 I.R.B. 150, announced that future

guidance would defer the applicability

date of the 2016 final regulations and

the related 2019 final regulations by one

additional year to taxable years beginning

after December 7, 2023. Thus, following

the amendments described in that Notice,

the 2016 final regulations and the related

2019 final regulations would first apply

to the taxable year beginning on January

1, 2024, for calendar year taxpayers. The

applicability date of §1.987-12 would not

be affected by these amendments.

VI. Financial Accounting Rules

The rules of the final regulations under

section 987 differ from the U.S. generally

accepted accounting principles (“U.S.

GAAP”) relating to foreign currency

translation gain or loss.1 For financial

accounting purposes, the consolidated

financial statements of a reporting entity

may include operations denominated or

measured in currencies other than the

reporting currency (each such operation,

a foreign entity),2 resulting in the need

to translate those operations into the

reporting currency of the reporting entity.

FASB, 2023, ASC par. 830-10-10-1. The

assets and liabilities and other elements,

such as revenues and expenses, of the

financial statements of a foreign entity

are translated to the reporting currency

using a current exchange rate. FASB,

2023, ASC pars. 830-30-45-3 through

830-30-45-5. For example, assets and liabilities of the foreign entity are translated

into the reporting currency using the spot

rate on the balance sheet date. Translation

adjustments resulting from the process

of translating a foreign entity’s financial

statements to the reporting currency are

not included in determining net income but

are reported in the cumulative translation

adjustment (CTA), which is part of other

comprehensive income, included in the in

the equity section of the reporting entity’s

consolidated balance sheet. FASB, 2023,

ASC par. 830-30-45-12. Upon the sale or

liquidation of the investment in the foreign entity, the CTA attributable to that

foreign entity is removed from equity and

is reported as part of the gain or loss on

the sale or liquidation of the investment.

FASB, 2023, ASC par. 830-30-40-1.

The treatment of translation gain or

loss under FASB, ASC Topic 830, under

which translation gain or loss is deferred

until a sale or liquidation, differs from

the requirements of section 987(3), under

which a taxpayer is required to make

proper adjustments for the transfer of

property between QBUs of a taxpayer

by including section 987 gain or loss in

income upon a remittance. Further, in contrast to the translation adjustments in the

financial accounting rules, which apply

to all assets and liabilities of a foreign

entity, the FEEP method imputes section

987 gain or loss only to marked items of a

section 987 QBU and requires the basis of

historic assets to be translated at historic

rates for purposes of computing section

987 taxable income or loss.

Explanation of Provisions

The proposed regulations retain the

basic approach and structure of the final

The relevant U.S. GAAP financial accounting rules are contained in Financial Accounting Standards Board (“FASB”), Accounting Standards Codification (“ASC”), Foreign Currency

Matters, Topic 830 (formerly known as FASB Statement No. 52, Foreign Currency Translation).

A foreign entity is an operation, including a subsidiary, division, and branch, whose financial statements are both (a) prepared in a currency other than the reporting currency of the reporting

entity, and (b) combined or consolidated with or accounted for on the equity basis in the financial statements of the reporting entity. FASB, 2023, ASC sec. 830-10-20.

December 11, 2023

1394

Bulletin No. 2023–50

regulations, while adopting a number of

the simplifications discussed in the Report

and providing additional guidance regarding the determination of section 987 taxable income or loss and section 987 gain

or loss.

I. FEEP Method

As explained in parts II.B and II.C of

the Background section, the final regulations provide that section 987 gain or loss

and section 987 taxable income or loss are

determined under the FEEP method. This

method uses a balance sheet approach

to determine section 987 gain or loss. In

addition, historic items are translated at

historic rates (both for purposes of determining section 987 gain or loss and for

purposes of translating recovery of basis

with respect to historic assets in computing section 987 taxable income or loss).

As a result, the FEEP method does not

impute section 987 gain or loss to historic

items, for which exchange rate changes

have only an uncertain or remote effect

on value that is more appropriately recognized upon a realization event.

Several comments asserted that the

FEEP method is overly complex and presents significant compliance burdens, primarily related to the treatment of historic

items. Comments stated that, because the

requirement to use historic rates to translate historic items diverges from financial

accounting rules, taxpayers would need to

keep a separate set of books with respect

to each section 987 QBU and to develop

costly reporting systems to maintain

information that is not used for any other

purpose.

Comments recommended that, to

reduce the complexity and administrative

burden of the final regulations, taxpayers

should be permitted to apply a method

similar to that provided in the 1991 proposed regulations. Comments noted that

this method could be coupled with rules

to prevent the selective recognition of section 987 losses, as discussed in part III of

this Explanation of Provisions.

The proposed regulations retain the

FEEP method of the 2016 final regulations, with modifications discussed in this

Explanation of Provisions, as the default

rule for determining section 987 taxable

income or loss and net unrecognized

section 987 gain and loss. See proposed

§§1.987-3 and 1.987-4. The FEEP method

is an appropriate default rule because it

generally provides a more precise measure of section 987 gain or loss. Moreover,

the enactment of the Tax Cuts and Jobs

Act, Public Law 115-97, 131 Stat. 2054

(2017), on December 22, 2017, has made

it even more important to accurately calculate taxable income with respect to a

section 987 QBU. For example, section

951A, relating to global intangible lowtaxed income (“GILTI”), has significantly

expanded the scope of taxable income of

a controlled foreign corporation (“CFC”)

that is subject to current U.S. taxation.3

In addition, because the 2016 final

regulations permit the yearly average

exchange rate to be used as the historic

rate, a taxpayer that knows the year in

which an asset was acquired or placed

in service can determine the applicable

historic rate based on publicly available information. Information relating to

the year in which an asset was acquired

or placed in service is often tracked for

other reasons, including for purposes of

computing depreciation and amortization.

For example, in computing a CFC’s qualified business asset investment, section

951A(d)(3)(A) now requires the adjusted

basis of assets to be determined using the

alternative depreciation system under section 168(g).

However, the Treasury Department and

the IRS acknowledge that in some cases it

may be burdensome to translate the basis

of each historic asset using a different historic rate (including for purposes of depreciation) in determining section 987 taxable

income or loss. Accordingly, as described

in parts II and IV of this Explanation of

Provisions, the proposed regulations provide several simplifying elections that

permit section 987 to be applied in a way

that more closely conforms to the financial accounting rules and reduces the

compliance burden. Taxpayers who make

these elections would still compute section 987 gain or loss by reference to the

year-end balance sheet of the section 987

QBU (though the computation would be

modified, as described in part V of this

Explanation of Provisions). The proposed

regulations do not include an election to

use the method prescribed in the 1991

proposed regulations, because the use of

fundamentally different computational

methods by different taxpayers (or by the

same taxpayer in different years) would

increase the complexity of the section 987

regulations and make them more difficult

to administer.

II. Current Rate Election

As discussed in part I of this Explanation

of Provisions section, comments noted

that the compliance burden associated

with the FEEP method relates primarily

to the treatment of historic items. Under

the 2016 final regulations, taxpayers are

required to track the historic rate for historic items and to use the historic rate for

purposes of computing section 987 taxable income or loss and section 987 gain

or loss.

To alleviate this compliance burden,

proposed §1.987-1(d)(2) would provide

an election to treat all items that are properly reflected on the books and records

of a section 987 QBU as marked items

(the “current rate election”). If a current

rate election applies, all items of income,

gain, deduction, and loss with respect to a

section 987 QBU would be translated at

the yearly average exchange rate for the

current taxable year for purposes of computing section 987 taxable income or loss.

See proposed §1.987-3(c)(2). In addition,

all items of a section 987 QBU would be

translated at the year-end spot rate for purposes of computing section 987 gain or

loss.

The current rate election is expected

to produce an amount of section 987 gain

or loss and section 987 taxable income or

loss that is similar to the amounts determined under the 1991 proposed regulations. If a current rate election is made, all

assets and liabilities of a section 987 QBU

would generate section 987 gain or loss,

in conformity with the approach used for

financial reporting purposes and the 1991

proposed regulations.

Previously, section 987 gain or loss recognized by a CFC generally would be taken into account in determining a U.S. shareholder’s taxable income only if a portion of the section 987 gain

or loss affected the calculation of subpart F income or when the earnings of the CFC were relevant, such as on a distribution or sale.

Bulletin No. 2023–50

1395

December 11, 2023

In general, a current rate election would

increase the pool of net unrecognized section 987 gain or loss with respect to a section 987 QBU (relative to the pool that

would be determined without the current

rate election). In addition, under a current

rate election amounts in the pool may substantially exceed any economic gain or

loss attributable to currency fluctuations.

The Treasury Department and the IRS

are concerned that without appropriate

limitation, the current rate election would

facilitate the abuses and inappropriate

outcomes that occurred under the 1991

proposed regulations, including the potential for taxpayers to choose to recognize

significant, and potentially uneconomic,

section 987 losses while avoiding or

deferring section 987 gains. Accordingly,

the proposed regulations include a rule

that would suspend the recognition of section 987 loss when a current rate election

is in effect. See part III of this Explanation

of Provisions.

III. Suspension of Section 987 Loss

Under a Current Rate Election

Comments discussed several options

for addressing the potential for selective

recognition of section 987 losses. First,

comments asserted that certain rules provided in the 2016 final regulations (for

example, the annual netting of contributions and distributions to determine the

amount of a remittance under §1.9875(c)) would be sufficient to prevent abuse.

Alternatively, comments recommended

that the recognition of section 987 gain or

loss be deferred until a QBU is terminated

or its assets are sold to an unrelated party,

consistent with the financial accounting rules. Comments also suggested that

section 987 loss could be deferred until

the owner recognizes an equal or greater

amount of section 987 gain from the same

QBU. Finally, some comments proposed

a “lookback” approach, under which section 987 loss would be deferred only to the

extent that the loss exceeded section 987

gain previously recognized with respect to

the same section 987 QBU.

The Treasury Department and the IRS

are concerned that, notwithstanding the

annual netting rule of §1.987-5(c) and

the other rules provided in the 2016 final

regulations, taxpayers generally have a

significant degree of control over whether

and when their section 987 QBUs make

remittances and, therefore, could still

selectively recognize section 987 losses.

In addition, because taxpayers that make a

current rate election are expected to have

substantial pools of net unrecognized

section 987 gain or loss, special rules are

needed to prevent the selective recognition of losses.

Accordingly, if a current rate election is

in effect, the proposed regulations generally would suspend the recognition of section 987 loss until a taxable year in which

an equal or greater amount of section 987

gain is recognized (as described in part

III.A of this Explanation of Provisions) or

until the occurrence of certain recognition

events (as described in part III.B of this

Explanation of Provisions).

A. General rules relating to suspended

section 987 loss

1. In General

In a taxable year in which a current

rate election applies, any section 987 loss

that would otherwise be recognized as a

result of a remittance (including a deemed

remittance resulting from the termination of a section 987 QBU) is treated as

suspended section 987 loss. Proposed

§1.987-11(c). In general, an owner of a

section 987 QBU would recognize suspended section 987 loss in a taxable year

in which the owner recognizes section 987

gain that has the same source and character as the suspended section 987 loss

(the “loss-to-the-extent-of-gain rule”).

Proposed §1.987-11(e). Whether section

987 gain has the same source and character as suspended section 987 loss would

be determined on the basis of the initial

assignment in proposed §1.987-6(b)(2)(i).

See proposed §1.987-11(e)(1) and (f).

The Treasury Department and the IRS

considered applying the loss-to-the-extent-of-gain rule at the QBU level, such

that suspended section 987 loss with

respect to a section 987 QBU would be

recognized only to the extent of section

987 gain recognized with respect to the

same section 987 QBU (as was recommended by some comments). However,

the Treasury Department and the IRS were

concerned that a QBU-level limitation

would be overly restrictive. Moreover, if

an owner has suspended section 987 loss

with respect to one QBU, the concern of

selective loss recognition may be mitigated to the extent that the same owner

recognizes section 987 gain with respect

to another QBU.

Therefore, under the proposed regulations, the loss-to-the-extent-of-gain rule

applies at the owner level. An owner of a

section 987 QBU recognizes suspended

section 987 loss to the extent that it recognizes section 987 gain, regardless of

which QBU generates the gain. However,

because this rule applies at the owner

level, the Treasury Department and the

IRS were concerned that an owner might

trigger the recognition of section 987 gain

that is not subject to residual U.S. tax (or

is taxed at a low rate) to release suspended

section 987 loss of a different source or

character. Accordingly, proposed §1.98711(e)(1) provides that an owner does not

recognize suspended section 987 loss until

it recognizes section 987 gain in the same

recognition grouping as the suspended

section 987 loss.

In general, section 987 gain and suspended section 987 loss are in the same

recognition grouping if they are both initially assigned to U.S. source income or

to foreign source income in the same section 904 category. Proposed §1.987-11(f)

(1). In addition, if the owner of a section

987 QBU is a CFC, in order to be in the

same recognition grouping, section 987

gain and suspended section 987 loss must

both be initially assigned to the same statutory and residual grouping of subpart F

income, tentative tested income, income

described in section 952(b) (certain

income that is effectively connected with

the conduct of a trade or business within

the United States (“ECI”) and excluded

from subpart F income), or other income.4

Proposed §1.987-11(f)(2).

Suspended section 987 loss that is not

recognized in a taxable year is recognized

See part VI of this Explanation of Provisions (requesting comments concerning the treatment of section 987 gain or loss as ECI).

December 11, 2023

1396

Bulletin No. 2023–50

in the next taxable year in which (and

to the extent that) the owner recognizes

section 987 gain in the same recognition

grouping. The Treasury Department and

the IRS also considered a lookback rule,

under which suspended section 987 loss

could be recognized to the extent that section 987 gain was recognized in a prior

taxable year. However, a lookback rule

would permit taxpayers to selectively

trigger section 987 gain in taxable years

in which such gain would not give rise to

additional U.S. tax (for example, because

the gain is offset by losses or because the

additional U.S. tax is offset with foreign

tax credits). In light of these concerns, the

Treasury Department and the IRS request

comments regarding, if a lookback rule

were to be adopted, how to prevent section 987 gain that has no net effect on U.S.

tax from releasing suspended section 987

loss that reduces U.S. tax.

2. Suspension of Section 987 Loss When

an Annual Recognition Election Is Made

In general, a taxpayer who makes an

annual recognition election will recognize the full amount of net unrecognized

section 987 gain or loss that is added to

the pool each year. If an annual recognition election and a current rate election

are both in effect for a taxable year, section 987 loss generally would not be suspended under proposed §1.987-11(c). See

part IV of this Explanation of Provisions.

The Treasury Department and the IRS

are concerned that taxpayers who are subject to a current rate election might seek

to avoid the application of the loss-to-theextent-of-gain rule by making an annual

recognition election after net unrecognized section 987 loss has accrued.

Similarly, the Treasury Department and

the IRS are concerned that taxpayers that

have not made a current rate election, but

which have substantial pools of net unrecognized section 987 loss, might make an

annual recognition election to recognize

the loss without the need for a remittance.

Accordingly, the proposed regulations

would treat any net accumulated unrecognized section 987 loss and deferred

section 987 loss as suspended section 987

loss in the first year in which an annual

recognition election takes effect if either

(1) a current rate election was in effect

Bulletin No. 2023–50

in the previous year or (2) the owner had

more than $5 million of net section 987

losses. Proposed §1.987-11(d).

3. Recognition of Suspended Section

987 Loss When an Annual Recognition

Election Is in Effect

The proposed regulations also contain

a special rule relating to the recognition

of suspended section 987 loss when a

current rate election and an annual recognition election are both in effect. The

Treasury Department and the IRS are

concerned that, absent a modification

to the general loss-to-the-extent-of-gain

rule in proposed §1.987-11(e)(1), taxpayers that have suspended section 987 loss

would get an unwarranted benefit from

making an annual recognition election.

Specifically, absent a modification, these

taxpayers would be able to recognize suspended section 987 loss even if they had

net losses on a cumulative basis for the

taxable years to which the annual recognition election applied.

For example, assume that an owner of

a section 987 QBU has suspended section

987 loss of $400 that arose in prior years

(for example, under a current rate election). The owner’s functional currency is

the U.S. dollar, and the section 987 QBU’s

functional currency is the euro. In year 1,

the owner makes an annual recognition

election. The euro weakens in year 1 and

partially recovers in year 2. As a result of

the annual recognition election, the owner

recognizes section 987 loss of $200 in

year 1 and recognizes section 987 gain of

$150 in year 2. Under the general loss-tothe-extent-of-gain rule in §1.987-11(e)(1),

even though the owner recognized net section 987 loss of $50 on a cumulative basis

(over years 1 and 2), the owner would recognize suspended section 987 loss equal

to the section 987 gain in the same recognition grouping that it recognizes in year

2. Assuming all of the section 987 gain or

loss is in the same recognition grouping,

the owner would recognize $350 of total

section 987 loss (equal to $200 of section

987 loss recognized under the annual recognition election in year 1 and $150 of

suspended section 987 loss recognized

under the loss-to-the-extent-of-gain rule

in year 2), even though it recognizes only

$150 of section 987 gain.

1397

Accordingly, if a taxpayer makes both

an annual recognition election and a current rate election, the loss-to-the-extentof-gain rule would apply by reference

to the net cumulative amount of section

987 gain in each recognition grouping that is recognized by the taxpayer

during the relevant testing period (rather

than the gross amount recognized each

taxable year). Proposed §1.987-11(e)

(2). The testing period generally is the

period in which section 987 loss is suspended and both a current rate election

and an annual recognition election are in

effect. Proposed §1.987-11(e)(2)(iii). The

Treasury Department and the IRS request

comments on whether any modifications

to the limitation in proposed §1.987-11(e)

(2) would allow for simplification while

preventing inappropriate outcomes.

B. Suspended section 987 loss recognized

or attributed to a successor on

termination

The proposed regulations provide a

successor rule that applies when a section

987 QBU with suspended section 987 loss

terminates. Under the successor rule, suspended section 987 loss is not recognized

in the taxable year of termination, but

instead becomes attributable to a successor suspended loss QBU.

For this purpose, an eligible QBU is

treated as a successor of a section 987

QBU if it holds a significant portion of

the assets of the section 987 QBU following its termination, is engaged in the

same trade or business, and is owned by

the owner of the section 987 QBU or a

member of the owner’s controlled group.

Proposed §1.987-13(b)(1). For this purpose, any eligible QBU may qualify as a

successor, whether or not it is a section

987 QBU (that is, whether or not it has

a different functional currency than its

owner). Thus, for example, if an owner of

a section 987 QBU with suspended section

987 loss contributes the assets of the section 987 QBU to a subsidiary where they

are held by an eligible QBU of the subsidiary that uses them in the same trade or

business (the “subsidiary QBU”), the subsidiary QBU is a successor suspended loss

QBU even if it is not a section 987 QBU.

Similar principles apply when a successor

terminates. Proposed §1.987-13(c)(1).

December 11, 2023

If a section 987 QBU (or its successor)

terminates without a successor, the original owner of the section 987 QBU recognizes all of its suspended section 987

loss with respect to the section 987 QBU

(or its successor). Proposed §1.987-13(b)

(2) and (c)(2). Therefore, an owner generally would recognize suspended section

987 loss when it transfers the section 987

QBU’s assets to an unrelated party or

the section 987 QBU ceases its trade or

business (such that there is no successor

suspended loss QBU). These events are

similar to the events that result in a release

of the CTA for financial reporting purposes. Moreover, the Treasury Department

and the IRS expect that taxpayers would

be less likely to sell or wind up the trade

or business of a section 987 QBU for the

purpose of selectively recognizing section

987 losses and, accordingly, there is less

of a need for continued suspension of section 987 loss after these events occur.

In addition, suspended section 987 loss

is recognized if the owner of the successor ceases to be related to the original

owner of the suspended loss QBU due

to a direct or indirect transfer of interests

in the owner of the successor. Proposed

§1.987-13(d). If the owner of a successor

suspended loss QBU ceases to be related

to the original owner of the section 987

QBU for a different reason (for example,

due to a transfer of interests in the original

owner of the suspended loss QBU), the

successor suspended loss QBU is no longer treated as a successor, and suspended

section 987 loss can no longer be recognized in connection with a termination

(though it can still be recognized under the

loss-to-the-extent-of-gain rule). Proposed

§1.987-13(e). This rule is intended to prevent taxpayers from transferring the stock

of the original owner out of its controlled

group for the purpose of selectively recognizing suspended section 987 loss, while

leaving behind the assets and activities of

the section 987 QBU in the hands of a different controlled group member.

Similarly, suspended section 987 loss

is not recognized when the owner of a

section 987 QBU liquidates in a transaction described in section 331. Proposed

§1.987-13(f). Instead, suspended section

987 loss that is not recognized in the taxable year of the liquidation is eliminated

and will never be recognized. This rule

December 11, 2023

is intended to prevent taxpayers from

entering into section 331 transactions in

order to trigger the recognition of suspended section 987 loss. For example, a

U.S. shareholder could cause an upper-tier

CFC that owns a section 987 QBU with

suspended section 987 loss to transfer all

of its assets and liabilities to a lower-tier

CFC in a section 351 contribution, and

then cause the upper-tier CFC to liquidate

in a transaction described in section 331

in order to recognize the suspended loss.

The Treasury Department and the IRS are

aware that similar transactions have been

used to claim large section 987 losses

under current law.

In the case of a combination or separation, the suspended section 987 loss of

a combined or separated QBU is determined under rules similar to those applicable to net accumulated unrecognized

section 987 gain or loss under proposed

§1.987-4(f). Proposed §1.987-11(b)(2)

and (3). Therefore, the suspended section

987 loss of a separating QBU is allocated

to the separated QBUs in proportion to the

assets properly reflected on the books and

records of each separated QBU after the

separation. Proposed §1.987-11(b)(3)

C. Special rule for inbound liquidations

and reorganizations

Under the proposed regulations, if a

foreign corporation liquidates or merges

into a domestic corporation in a section

381(a) transaction, the domestic corporation does not succeed to or take into

account any unused suspended section 987

loss of the foreign corporation. Proposed

§1.987-13(g). This rule is intended to prevent the importation of suspended section

987 loss that was generated offshore. Due

to differences in how income of a CFC is

taxed to its U.S. shareholders, these losses

may relate to income subject to tax at a

significantly reduced effective rate. For

example, a suspended section 987 loss

that is allocated and apportioned to the

other income grouping under proposed

§1.987-6 may effectively reduce only

earnings that would typically not be subject to current U.S. tax, and which may be

eligible for a dividends received deduction

under section 245A upon distribution. As

a result, depending on the particular facts,

such losses may have little or no impact

1398

on the U.S. tax liability of a CFC’s U.S.

shareholder when they are recognized and

are generally not equivalent to the section

987 gains or losses typical of a domestic

corporation.

Furthermore, even if the domestic corporation could, in theory, succeed to the

suspended section 987 loss, the loss may

have been assigned to an income group,

such as the tested income group, that is

not relevant to a domestic corporation, in

which case, it would be highly unlikely

that the suspended section 987 loss could

ever be used (absent a subsequent outbound asset transfer by the domestic corporation to a foreign successor) under the

loss-to-the-extent-of-gain rule because the

domestic corporation would not recognize

section 987 gain in the same recognition

grouping.

D. Rejection of financial accounting

deferral rule

The Treasury Department and the IRS

also considered a rule that would defer

the recognition of all section 987 gain

and loss of a section 987 QBU until a taxable year in which the section 987 QBU’s

trade or business ceases to be performed

by any member of the controlled group or

substantially all of the assets and activities of the QBU are transferred outside

of the controlled group. This approach

would more closely parallel the rules for

determining when the CTA is released for

financial accounting purposes.

However, the loss limitation rule provided in the proposed regulations is more

consistent with the statutory provisions

of section 987(3), which contemplates

the recognition of section 987 gain or

loss at the time of a remittance, and section 989(c)(2), which authorizes regulations limiting the recognition of foreign

currency loss on certain remittances.

Moreover, the Treasury Department and

the IRS are concerned that a rule that

defers the recognition of all section 987

gain or loss may be difficult to administer.

For example, as a practical matter, taxpayers might not properly track section 987

gain or loss on an annual basis if it is not

expected to be recognized in the foreseeable future and the sale or liquidation of a

section 987 QBU might occur many years

after the accrual of section 987 gain or

Bulletin No. 2023–50

loss (at which time the necessary records

may no longer be available).

IV. Annual Recognition Election

A. Annual deemed termination election

provided in the 2016 temporary and

proposed regulations

As explained in part II.D of the

Background section, the 2016 temporary and proposed regulations contained

an annual deemed termination election.

Under this election, a section 987 QBU

would be deemed to terminate on the last

day of each taxable year, resulting in the

remittance of all the gross assets of the

section 987 QBU to its owner and the recognition of all net unrecognized section

987 gain or loss on an annual basis. See

§§1.987-8T(d) and 1.987-8(e). The assets

and liabilities of a section 987 QBU subject to the election would then be deemed

to be contributed to the section 987 QBU

on the first day of the following taxable

year. See §1.987-8T(d).

A comment asserted that it was difficult to apply the rules under the annual

deemed termination election. If the election was made, a section 987 QBU’s historic assets and the amount of its historic

liabilities would be translated at the end

of each year into the owner’s functional

currency using historic rates (due to the

deemed termination and remittance); the

historic rate would generally be the yearly

average exchange rate for the year of the

deemed termination. The assets and liabilities would then be retranslated into the

section 987 QBU’s functional currency

at the beginning of the following taxable

year at the yearly average exchange rate

for the following taxable year (due to the

deemed contribution). See §§1.987-2(d)(2)

and 1.987-5(f)(3). As a result, the basis of

a section 987 QBU’s assets and the amount

of its liabilities (determined in the section

987 QBU’s functional currency) generally

would change from one year to the next,

which would increase the compliance burden of applying the section 987 regulations.

B. Annual recognition election provided

in the proposed regulations

The proposed regulations would

replace the annual deemed termination

Bulletin No. 2023–50

election with an annual recognition election. Like the annual deemed termination

election, an owner that makes the annual

recognition election would recognize the

full amount of net unrecognized section

987 gain or loss each year. However, the

proposed annual recognition election does

not result in a deemed termination of a section 987 QBU and a deemed remittance of

its assets or a deemed contribution to the

section 987 QBU. Instead, the owner of a

section 987 QBU simply recognizes the

full amount of its net unrecognized section 987 gain or loss on an annual basis.

Therefore, the annual recognition election

would not alter the functional currency

basis of a section 987 QBU’s assets, the

amount of its liabilities, or their historic

exchange rates.

C. Special rules that apply when a

current rate election and an annual

recognition election are both in effect

The annual recognition election is available to owners whether or not they make

a current rate election. If an owner makes

both an annual recognition election and

a current rate election for a taxable year,

the loss suspension rule described in part

III of this Explanation of Provisions does

not apply to net unrecognized section 987

loss accrued while the election is in effect.

Because the annual recognition election

requires both gains and losses to be recognized without regard to whether a remittance occurs, selective recognition of losses

is not possible and, accordingly, a loss limitation should not be needed. However,

see part III.A.3 of this Explanation of

Provisions regarding the application of the

loss-to-the-extent-of-gain rule when an

annual recognition election is in effect.

D. Translation of taxable income under

an annual recognition election when a

current rate election is not in effect

If an owner of a section 987 QBU

makes an annual recognition election,

but does not make a current rate election, section 987 taxable income or loss

is determined by translating all items at

the yearly average exchange rate. Unlike

under the 2016 temporary and proposed

regulations, this rule is mandatory (rather

than elective). Use of the yearly average

1399

exchange rate simplifies the determination of section 987 taxable income or loss

without sacrificing accuracy and is consistent with financial accounting principles.

Therefore, an election to use historic rates

for this purpose should not be needed.

E. Consequences of making an annual

recognition election if a current rate

election is not in effect

As described in part IV.D of this

Explanation of Provisions, if an owner

of a section 987 QBU makes an annual

recognition election, and does not make

a current rate election, the owner would

use the yearly average exchange rate for

purposes of determining section 987 taxable income or loss. However, the owner

would use historic rates to translate historic items for purposes of determining

section 987 gain or loss. Thus, the same

historic item would be translated at different exchange rates for different purposes. Under the mechanics of the FEEP

method, if a historic asset is sold or

depreciated during the taxable year, the

difference between the historic rate basis

and the current year average rate basis

would be added to the pool of unrecognized section 987 gain or loss (and recognized pursuant to the annual recognition

election).

The effect of these rules is that—

with respect to historic assets of a section 987 QBU—an owner that does not

make a current rate election would recognize the same total amount of taxable

income each year regardless of whether

it makes an annual recognition election.

For example, assume a section 987 QBU

has the euro as its functional currency,

and its owner is a calendar year taxpayer

with the U.S. dollar as its functional currency. At the end of year 1, the section

987 QBU owns a non-depreciable historic asset (Asset A) with a basis of 100

euros, and the historic rate for Asset A is

€1=$1. The yearly average exchange rate

in year 2 and the spot rate on December

31, year 2 is €1=$2. In year 2, the section

987 QBU sells Asset A for 150 euros and

holds the 150 euros on its balance sheet

until the end of year 2.

If the owner does not make an annual

recognition election, the owner will have

section 987 taxable income of $200 for

December 11, 2023

year 2. This reflects the excess of the

amount realized (150 euros, translated at

the yearly average exchange rate of €1=$2

into $300) over the basis of Asset A (100

euros, translated at the historic rate of

€1=$1 into $100). The owner will have

no unrecognized section 987 gain or loss

for the taxable year under §1.987-4(d). A

comparison of the year 2 and year 1 yearend balance sheets under §1.987-4(d)(1)

will reflect an increase of $200 (the excess

of 150 euros held at the end of year 2,

translated at the year 2 year-end spot rate

of €1=$2 into $300, over the €100 basis

of Asset A, which was held at the end of

year 1, translated at the historic rate of

€1=$1 into $100). However, this increase

is fully offset by the negative adjustment

for taxable income of $200 under §1.9874(d)(6).

By contrast, if the owner makes an

annual recognition election, the owner

will have section 987 taxable income in

year 2 of only $100 (50 euros of taxable

income, translated at the yearly average

exchange rate of €1=$2). The owner

will also have unrecognized section 987

gain for the taxable year of $100 under

§1.987-4(d), which reflects the balance

sheet increase of $200 (computed under

§1.987-4(d)(1) as described in the preceding paragraph) reduced by the negative adjustment for taxable income

of $100. Thus, the difference between

Asset A’s basis translated at the yearly

average exchange rate (which is $200)

and its basis translated at the historic

rate (which is $100) is added to the

pool of unrecognized section 987 gain

or loss and this amount is recognized

in year 2 due to the annual recognition

election.

The example illustrates that, whether

or not the annual recognition election

is made, the owner recognizes the same

amount of total income with respect to

Asset A (that is, $200). However, the

annual recognition election has the effect

of converting a portion of the owner’s

income into section 987 gain or loss.

Because section 987 gain or loss is subject to special source and character rules

under proposed §1.987-6, the annual

recognition election can change the

source and character of an owner’s taxable income.

V. Changes to the Computation of

Unrecognized Section 987 Gain or Loss

for a Taxable Year

F. Impact of an annual recognition

election on the timing of recognition with

respect to marked and historic items

The proposed regulations contain several changes to the computation of unrecognized section 987 gain or loss for a

taxable year under §1.987-4(d) (that is,

the amount added to the pool of net unrecognized section 987 gain or loss each

year).5 These modifications are intended

to ensure that section 987 gain or loss is

attributable only to exchange rate fluctuations. For example, the proposed regulations would modify the adjustments for

tax-exempt income and non-deductible

expenses to cover all items of income,

gain, deduction, or loss that affect the section 987 QBU’s balance sheet but are not

taken into account in determining section

987 taxable income or loss for the taxable year. Proposed §1.987-4(d)(7) and

(8). The proposed regulations would also

require an adjustment for items of income,

gain, deduction, or loss that are taken into

account in determining section 987 taxable income or loss but do not affect the

section 987 QBU’s balance sheet for the

taxable year. Proposed §1.987-4(d)(9).

Thus, the proposed regulations would

account for deferred items that are

expected to be taken into account in computing taxable income in a subsequent

year by taking them into account in the

year in which they impact the section 987

QBU’s balance sheet and effectively backing them out in the future year when they

impact taxable income but do not change

the balance sheet. For example, if a section 987 QBU incurs an expense in year

1, but the deduction associated with the

expense is deferred until year 5, proposed

§1.987-4(d)(7) would treat the expense

as a non-deductible expense in year 1,

increasing the year 1 unrecognized section

987 gain or loss. In year 5, the deduction

would have no net effect on unrecognized

section 987 gain or loss, since the deduction would result in a positive adjustment

under proposed §1.987-4(d)(6) (because

the deduction reduces taxable income, and

taxable income is a negative adjustment to

unrecognized section 987 gain or loss),

Under an annual recognition election,

section 987 gain or loss with respect to

marked items would be recognized annually (whereas, in the absence of an annual

recognition election, section 987 gain or

loss would be deferred until the section

987 QBU makes a remittance). Therefore,

with respect to marked items, an annual

recognition election would accelerate the

recognition of section 987 gain or loss. If

a current rate election is in effect, all items

of the section 987 QBU will be treated as

marked items generating section 987 gain

or loss; this gain or loss would be accelerated if an annual recognition election is

made.

However, if a current rate election

is not in effect, the annual recognition

election would not accelerate the recognition of income with respect to historic assets. As explained in part IV.E

of this Explanation of Provisions, in

the absence of a current rate election,

the owner of a section 987 QBU recognizes the same amount of total income

with respect to historic assets whether

or not an annual recognition election

is in effect (though the annual recognition election has the effect of changing

the portion of the income that is section

987 gain or loss and the portion that is

section 987 taxable income or loss). In

addition, as explained in part IV.D of

this Explanation of Provisions, an annual

recognition election is expected to simplify the computation of section 987 taxable income or loss (because all items

would be translated at the yearly average

exchange rate). Therefore, for section

987 QBUs that do not have a significant

amount of marked assets or liabilities,

the election is expected to reduce the

compliance burden on taxpayers without

materially accelerating the recognition

of income.

Proposed §1.987-4(g) contains new examples illustrating the proposed modifications to the computation of unrecognized section 987 gain or loss under proposed §1.987-4(d). The Treasury

Department and the IRS intend to make conforming changes to the existing examples in §1.987-4 of the final regulations when the proposed regulations are finalized.

December 11, 2023

1400

Bulletin No. 2023–50

and an offsetting negative adjustment

under proposed §1.987-4(d)(9) (since the

deduction represents a taxable deduction

that does not affect the balance sheet). As

a result, the expense would impact the calculation of section 987 gain or loss in the

same manner as if it had been deductible

in year 1.

In addition, the proposed regulations

require an adjustment to unrecognized

section 987 gain or loss for any residual

increase or decrease to the adjusted balance

sheet of the section 987 QBU (determined

in the functional currency of the section

987 QBU) that is not accounted for under

the other computational steps. Proposed

§1.987-4(d)(10). This residual amount

is translated into the owner’s functional

currency at the yearly average exchange

rate. The residual increase or decrease is

computed by applying the other computational steps described in proposed §1.9874(d) (steps 1 through 9) in the functional

currency of the section 987 QBU. Because

these steps must already be performed in

the owner’s functional currency, determining the residual increase or decrease to

the adjusted balance sheet under proposed

§1.987-4(d)(10) is not expected to significantly increase the burden of determining

net unrecognized section 987 gain or loss.

The application of proposed §1.9874(d)(10) would ensure that non-currency-related changes to the balance sheet

do not artificially increase or decrease

the pool of net unrecognized section

987 gain or loss. However, if the computational steps are applied correctly in

the functional currency of a section 987

QBU, there should not be any residual

increase or decrease to the balance sheet

under proposed §1.987-4(d)(10) (unless a

current rate election or an annual recognition election is made). Rather, the yearover-year increase (or decrease) to the

functional currency balance sheet (step

1) should equal the functional currency

amount of net transfers to the section 987

QBU (steps 2 through 5) and income of

the section 987 QBU (steps 6 through 8),

after backing out items of income that do

not impact the balance sheet (step 9). By

contrast, when these steps are applied in

owner functional currency, they serve to

identify the balance sheet change attributable to currency movements.

For taxpayers that make a current rate

election or an annual recognition election,

the proposed regulations provide that steps

6 through 9 of the computation (relating

to income, gain, deduction, or loss) do

not need to be applied. For these taxpayers, all items of income, gain, deduction,

or loss would be taken into account as a

residual increase or decrease to the section 987 QBU’s balance sheet and translated at the yearly average exchange rate.

The Treasury Department and the IRS

request comments on whether any additional adjustments are needed for section

988 gain or loss of a section 987 QBU that

is subject to a current rate election or an

annual recognition election. See part XV

of this Explanation of Provisions (requesting comments as to whether section 988

gain or loss of a section 987 QBU should

be determined in the owner’s functional

currency or the section 987 QBU’s functional currency).

VI. Source and Character of Section 987

Gain or Loss

The final regulations provide that the

source and character of section 987 gain

or loss is determined in the year of a remittance using the asset method of §§1.8619(g) and 1.861-9T(g). See §1.987-6(b)(2).

For this purpose, only the assets of the

section 987 QBU are taken into account.

The proposed regulations would generally retain this character and source rule,

subject to certain modifications, and

would further provide that taxpayers must

apply only the tax book value method in

characterizing the assets under proposed

§§1.861-9(g) and 1.861-9T(g).6 See proposed §1.987-6(b)(2)(i)(A).

Proposed §1.987-6(b)(2)(i) would provide special rules for the application of the

tax book value method for initially characterizing section 987 gain or loss. Under

these proposed regulations, the assets of

the section 987 QBU would be initially

assigned to statutory and residual groupings under the tax book value method.

However, to prevent circularity, the proportions in which the tax book value of the

assets would be initially assigned to the

statutory and residual groups are determined without regard to section 987 gain

or loss. Proposed §1.987-6(b)(2)(i)(B).

The initial assignment would occur after

the application of the income attribution

rules of §1.904-4(f)(2)(vi) or 1.951A-2(c)

(7) (or the principles of these rules), but

before expenses are allocated and apportioned to gross income and before the

application of provisions that require a

net income computation, such as the hightax exception to passive category income

in §1.904-4(c), the high-tax exception to

foreign base company income in §1.9541(d), and the high-tax exclusion from

tested income in §1.951A-2(c)(7).

In addition, because, at the time of the

initial assignment, a taxpayer may not

yet know whether a GILTI high-tax election will be in effect in the taxable year

in which the section 987 gain or loss is

recognized (since deferred section 987

gain or loss and suspended section 987

loss may be recognized in future year),

the proposed regulations would initially

assign all of the section 987 gain or loss

that would have been assigned to a tested

income group if no GILTI high-tax election was in effect to a tentative tested

income group. See proposed §1.987-6(b)

(2)(i)(D).

The initial assignment would generally be made in the taxable year in which

section 987 gain or loss is treated as recognized, deferred, or suspended under

proposed §1.987-6(b)(1). Then, in the

taxable year in which the section 987

gain or loss is recognized (which may

be the same taxable year as the year in

which the initial assignment was made

or a future taxable year), any section 987

gain or loss that was initially assigned to

a tentative tested income group would

be reassigned to a tested income group

or residual group based on whether the

GILTI high-tax election is in effect in

that taxable year and, if so, whether the

income is high-tax. The initial characterization under proposed §1.987-6(b)(2)(i)

would be used for purposes of applying

The proposed regulations would also make a clarifying change to §1.861-9T(g)(2)(ii)(A)(1) to clarify that the references to beginning-of-year and end-of-year functional currency amounts

are to the owner functional currency amounts and to move certain provisions from §1.861-9T to proposed §1.861-9.

Bulletin No. 2023–50

1401

December 11, 2023

the loss-to-the-extent-of-gain rule in

proposed §1.987-11(e) and (f), and also

applies as the starting point for net income

calculations required for other provisions

such as the high-tax exception to passive

category income under §1.904-4(c) and

the GILTI and subpart F high-tax exceptions under §§1.954-1(d) and 1.951A-2(c)

(7). Proposed §1.987-6(b)(2)(ii).

Proposed §1.987-6(b)(2)(iii) would

also provide that if a GILTI high-tax

election is made under §1.951A-2(c)(7)

(viii), it applies to all of the section 987

gain or loss in a tentative tested income

group that is recognized by the CFC in the

taxable year as if the section 987 gain and

loss were all assigned to its own separate

tested unit of the CFC. In other words, all

section 987 gain or loss recognized by

the CFC in that taxable year in the same

section 904 category would be treated as

a single tentative tested income item for

purposes of applying the GILTI high-tax

exclusion.

For example, if section 987 gain and

loss in a section 904 category is initially

assigned to a tentative tested income

group under proposed §1.987-6(b)(i) and

a GILTI high-tax election is in effect in

the year in which the section 987 gain or

loss is recognized, the section 987 gain or

loss in the section 904 category would be

treated as its own tentative tested income

item for purposes of determining whether

it is excluded from tested income under

§1.951A-2(c)(7), after which the section

987 gain or loss will be reassigned to a

tested income group (if the item is not

excluded from tested income) or to the

residual category (if the item is excluded

from tested income). Because foreign

countries generally do not impose tax on

section 987 gain, allocation and apportionment of a foreign income tax to section

987 gain under §1.861-20 and proposed

§1.987-6(b)(3) will likely be uncommon.

As a result, a tentative tested income

item consisting of section 987 gain may

often have a zero percent effective rate

of foreign tax and, therefore, would generally not qualify for the GILTI high-tax

exclusion.

As described above, the proposed regulations would provide that, for purposes

of determining the source and character

of section 987 gain and loss, the initial

assignment of suspended section 987

December 11, 2023

loss and deferred section 987 gain and

loss is generally made in the taxable year

it becomes suspended or deferred (generally in the year of a remittance or the

year the section 987 QBU is transferred

to a related party), rather than the taxable

year in which it is recognized. Proposed

§1.987-6(b)(1). The Treasury Department

and the IRS anticipate that making the initial assignment in the year of suspension

or deferral, rather than the year the section 987 gain or loss is recognized, will

generally result in determining the source

and character in a year closer in time to the

year in which the section 987 loss originated, and therefore will tend to be more

accurate. In addition, making an initial

assignment in the taxable year of deferral

or suspension means that the source and

character are determined by reference to

the assets of the section 987 QBU while

they are still owned by the owner, rather

than after they have been transferred,

which would be both administratively difficult and more likely to introduce distortions to the determination.

The Treasury Department and the IRS

request comments as to whether it would

be appropriate to determine the source and

character of unrecognized section 987 gain

or loss by making the initial assignment in

the taxable year in which the section 987

gain or loss is initially included in unrecognized section 987 gain or loss under

§1.987-4(d), rather than in the year of a

remittance. Making the initial assignment

on an annual basis would require more

extensive tracking of section 987 gain

or loss in separate categories. However,

this approach could avoid distortions that

could arise from changes in the bases of a

section 987 QBU’s assets or shifts in the

character of its income or assets between

the time unrecognized section 987 gain or

loss is added to the pool and the time it

is recognized. In addition, this approach

could align more closely with the character of income generated by the section 987

QBU’s assets at the time of the exchange

rate fluctuations that give rise to section

987 gain or loss.

The proposed regulations would not

change the rule in the final regulations

that section 987 gain or loss that is

assigned to a subpart F income group is

treated as foreign currency gain or loss

attributable to section 988 transactions

1402

not directly related to the business needs

of the CFC. See proposed §1.987-6(b)

(2)(i)(C). The Treasury Department and

the IRS request comments as to whether

it would be appropriate to eliminate this

rule and characterize section 987 gain

or loss by reference to subpart F income

groups (as defined in §1.960-1(d)(2)(ii)

(B)) or whether to retain this rule generally but apply a different rule to taxpayers that make a current rate election

(under which section 987 gain or loss can

arise with respect to assets that would not

generate section 988 gain or loss in the

hands of the owner).

A qualified business unit that produces income or loss that is, or is treated

as, ECI is required to use the dollar as

its functional currency. See §1.985-1(b)

(1)(v). The 2016 proposed regulations

would provide an election under which a

qualified business unit with a dollar functional currency may be treated as a section

987 QBU. See §1.987-1(b)(6)(iii) of the

2016 proposed regulations. The Treasury

Department and the IRS also request comments as to whether, and in what circumstances, section 987 gain or loss should be

treated as ECI.

VII. Expansion of Entities Covered

In general, the final regulations do

not apply to a bank, insurance company,

leasing company, finance coordination

center, regulated investment company, or

real estate investment trust (a “specified

entity”), unless it engages in transactions

primarily with related persons within

the meaning of section 267(b) or section

707(b) that are not themselves specified

entities. Additionally, the final regulations

do not apply to trusts, estates, S corporations, and partnerships other than section

987 aggregate partnerships. See §1.9871(b)(1)(ii).

The Treasury Department and the IRS

are concerned that excluding these entities

from the application of the regulations

under section 987 would not provide taxpayers with sufficient guidance to ensure

these entities are using an appropriate

method to calculate their section 987 gain

or loss. Furthermore, if these entities are

not subject to the regulations under section 987, they may use different methods of applying section 987 that vary in

Bulletin No. 2023–50

material ways. Applying a consistent set

of rules to all taxpayers facilitates the fair

and effective administration of the tax law

by treating similarly situated taxpayers

similarly as well as eliminating subjectivity and uncertainty.

In addition, the Treasury Department

and the IRS anticipate that the new current rate election and annual recognition

election described in parts II and IV of this

Explanation of Provisions would provide

sufficient flexibility to permit the entities

excluded under the 2016 final regulations

to apply the proposed regulations. As discussed in part VIII of this Explanation of

Provisions, the proposed regulations also

provide new rules relating to partnerships

(other than section 987 aggregate partnerships) and S corporations. See part VIII

of this Explanation of Provisions. These

rules are expected to significantly reduce

the administrative burden and complexity of applying section 987 to partnerships as compared to the aggregate rules.

Accordingly, proposed §1.987-1(b)(1)

(ii) generally removes the exclusion for

entities excluded from the 2016 final regulations, making them subject to the proposed regulations.

The proposed regulations generally

continue to exclude foreign non-grantor

trusts and foreign estates if the aggregate

interests of beneficiaries that are United

States persons is less than 10 percent, and

foreign partnerships if the aggregate interests of the partners that are United States

persons is less than 10 percent of the capital and profits interests. Proposed §1.9871(b)(1)(ii). The Treasury Department and

the IRS are concerned that the shareholders, partners, and beneficiaries of these

entities may not be able to obtain the information needed to apply the regulations to

these entities, and it would be difficult for

the IRS to administer the regulations with

respect to these entities. For the same reason, the proposed regulations generally

exclude foreign corporations that are not

CFCs and foreign corporations that are

CFCs but which have no U.S. shareholders (which are not excluded under the final

regulations). Foreign individuals are also

generally excluded as they are typically

not subject to U.S. tax.

The Treasury Department and the IRS

request comments on whether any additional rules are needed to facilitate the

application of the proposed regulations to

the entities that were excluded from the

2016 final regulations. See also part VIII

of this Explanation of Provisions, requesting comments on the application of the

proposed regulations to partnerships and

S corporations.

VIII. Partnerships

A. Background

As explained in part II.C of the

Background section, the 2006 proposed

regulations and 2016 final regulations

applied aggregate theory to partnerships.

As explained in the preamble to the 2006

proposed regulations, the 2006 proposed

regulations applied the FEEP method

directly at the partner level under aggregate theory with the goal of more appropriately preserving the correct amounts of

exchange gain or loss as measured from

the perspective of the partner. Measuring

the currency gain or loss by reference to

the partner, rather than the partnership,

was considered preferable because the

partners would generally bear the economic risk from the exposure.

Comments to the 2006 proposed regulations requested that the Treasury

Department and the IRS reconsider the

aggregate approach and instead treat a

partnership as a separate entity with its

own functional currency. The comments

indicated that the aggregate approach was

overly complex and that minority partners would not have the power to compel a partnership to provide them with

the information needed to make the calculations required under the aggregate

approach. One comment acknowledged

the economic rationale for the aggregate

approach but, in light of its complexity,

recommended that it apply only in cases

in which a partner’s interest in partnership

capital or profits exceeds a certain threshold, such as 10 percent.

In the preamble to the 2016 final regulations, the Treasury Department and the

IRS acknowledged concerns regarding

the complexity of the applying the aggregate approach to partnerships, but determined that it would be feasible to apply

an aggregate approach to partnerships

that are wholly owned by related persons.

Furthermore, the aggregate approach was

preserved in order to prevent a group

of related parties from holding eligible

QBUs through partnerships instead of

directly, and thereby altering the section

987 treatment of the eligible QBU without meaningfully altering the group’s economic position.

As a result, the 2016 final regulations

retained the aggregate approach to partnerships, but applied it only to section

987 aggregate partnerships, as discussed

in Part II.C of the Background section.

The 2016 final regulations did not address

other partnerships.

Under the aggregate approach set forth

in the 2016 final regulations, assets and liabilities reflected on the books and records

of an eligible QBU of a section 987 aggregate partnership are allocated to each partner, which is considered an indirect owner

of the eligible QBU. If the eligible QBU

has a different functional currency than its

indirect owner, then the assets and liabilities of the eligible QBU that are allocated

to the partner are treated as a section 987

QBU of the indirect owner.

B. Method for determining share of assets

and liabilities

The 2006 proposed regulations provided that a partner’s share of assets

and liabilities reflected on the books and

records of an eligible QBU is determined

in a manner consistent with how the partners had agreed to share the economic

benefits and burdens corresponding to

partnership assets and liabilities, taking

into account the rules and principles of

subchapter K.7

A comment noted that the rules in the

2006 proposed regulations for allocating assets and liabilities to a partner’s

indirectly owned section 987 QBU were

ambiguous and that the rules and principles of subchapter K do not provide sufficient guidance in this regard. The Treasury

Department and the IRS acknowledged

A partner’s basis in the partnership was adjusted to take into account any section 987 gain or loss that it recognized on any section 987 QBUs owned indirectly through the partnership.

Bulletin No. 2023–50

1403

December 11, 2023

the ambiguity in the preamble to the 2016

final regulations, and the 2016 temporary

regulations provided more specific rules

for determining a partner’s share of the

assets and liabilities reflected on the books

and records of an eligible QBU owned

indirectly through a section 987 aggregate

partnership.

In particular, the temporary regulations

provided that, in any taxable year, a partner’s share of each asset and liability of a

section 987 aggregate partnership was proportional to the partner’s liquidation value

percentage with respect to the aggregate

partnership. A partner’s liquidation value

percentage was defined as the ratio of the

liquidation value of the partner’s interest

in the partnership to the aggregate liquidation value of all the partners’ interests

in the partnership. The liquidation value of

the partner’s interest in the partnership was

defined as the amount of cash the partner

would receive with respect to its interest

if, immediately following the applicable

determination date, the partnership sold all

of its assets for cash equal to the fair market

value of such assets (taking into account

section 7701(g)), satisfied all of its liabilities (other than those described in §1.7527), paid an unrelated third party to assume

all of its §1.752-7 liabilities in a fully taxable transaction, and then liquidated.

Comments recommended alternative

approaches for determining a partner’s

share of the assets and liabilities of a

section 987 aggregate partnership. Some

comments recommended that §1.987-7

be withdrawn and replaced with the

approach of the 2006 proposed regulations under section 987, which provided

that a partner’s share of assets and liabilities reflected on the books and records of

an eligible QBU held indirectly through

the partnership must be determined in a

manner consistent with how the partners

have agreed to share the economic benefits and burdens corresponding to those

partnership assets and liabilities, taking

into account the rules and principles of

subchapter K. A comment indicated that

the liquidation value percentage approach

was inconsistent with certain principles of

subchapter K, resulting in distortions in

the calculation of section 987 gain or loss

in certain cases.

The Treasury Department and the IRS

determined that, in the absence of a more

December 11, 2023

comprehensive set of rules for determining

a partner’s share of assets and liabilities

reflected on the books and records of an

eligible QBU held indirectly through the

partnership that also articulates the interaction of those rules with applicable rules

in subchapter K, a more flexible approach

was warranted. Moreover, the Treasury

Department and the IRS determined that,

in certain instances, the liquidation value

percentage methodology set forth in the

2016 temporary regulations could be interpreted as applying in a way that inappropriately distorts the computation of section

987 gain or loss. Specifically, under such

an interpretation, certain changes in a partner’s liquidation value percentage could

introduce distortions in the calculation of

net unrecognized section 987 gain or loss

under §1.987-4, giving rise to net unrecognized section 987 gain or loss that is

not attributable to fluctuations in exchange

rates. For example, an appreciation or

depreciation in property value could result

in a change in liquidation value percentage

that causes a change in owner functional

currency net value for purposes of step 1

of the §1.987-4(d) calculation of unrecognized section 987 gain or loss for a taxable

year without creating an offsetting adjustment under step 6 or otherwise that would

prevent the change in liquidation value

percentage from distorting the calculation

of unrecognized section 987 gain or loss.

As a result, such unrecognized appreciation or depreciation generally could result

in unrecognized section 987 gain or loss

for a taxable year being allocated to each

partner that indirectly owned a section 987

QBU even when there was no change in

exchange rates.

Accordingly, the Treasury Department

and the IRS withdrew §1.987-7T in the

2019 final regulations. The preamble to

the 2019 final regulations stated that, until

new regulations are proposed and finalized, taxpayers may use any reasonable

method for determining a partner’s share

of assets and liabilities reflected on the

books and records of an eligible QBU held

indirectly through the partnership. For this

purpose, taxpayers may rely on subchapter K principles (consistent with the 2006

proposed regulations) or an approach similar to the liquidation value percentage

method set forth in §1.987-7T. However,

it would not be reasonable to apply the

1404

liquidation value percentage method in

§1.987-7T without corresponding adjustments to the determination of net unrecognized section 987 gain or loss. Thus, for

example, a taxpayer using the liquidation

value percentage method may be required

to adjust its determination of net unrecognized section 987 gain or loss of a section

987 QBU that is owned indirectly through

a partnership to prevent the determination

of unrecognized section 987 gain or loss

that is not attributable to fluctuations in

exchange rates. These adjustments may

include, for example, treating any change

in a partner’s owner functional currency

net value that is attributable to a change in

the partner’s liquidation value percentage

as resulting in a transfer to or from an indirectly owned section 987 QBU.

C. The proposed regulations apply entity

theory to non-section 987 aggregate

partnerships

As previously discussed in part

VIII.A of this Explanation of Provisions,

although the final regulations applied the

aggregate approach to section 987 aggregate partnerships, the final regulations did

not provide rules for applying section 987

to other partnerships. The preamble to the

2016 final regulations stated that section

987 regulations would be developed for

these other partnerships in a separate project and indicated that a different approach

might be taken. To that end, the preamble

requested comments on how an entity

approach should work for non-section 987

aggregate partnerships.

Several comments were received

asserting that the aggregate approach to

partnerships under the 2016 final regulations was overly complex. Comments recommended that a partnership be treated as

a separate entity with its own functional

currency that can be the owner of a section

987 QBU. Comments also indicated that

entity treatment would be more consistent

with the principles of subchapter K.

The Treasury Department and the IRS

agree that treating non-section 987 aggregate partnerships as an entity and therefore potentially an “owner” of section 987

QBUs would be more administrable than

an aggregate approach and would reduce

the compliance burden on taxpayers and the

IRS. However, the Treasury Department

Bulletin No. 2023–50

and the IRS continue to study whether partners might be able to achieve inappropriate

outcomes under entity theory. For example,

the Treasury Department and the IRS are

concerned that if partnerships maintained

section 987 gain and loss pools under a

“pure” entity theory paradigm, partners

would effectively be able to transfer their

share of net unrecognized section 987 gain

or loss to another partner, thereby avoiding

gain recognition or trafficking in losses. To

prevent a partner from transferring its share

of net unrecognized section 987 gain or loss

to another partner, the proposed regulations

would generally apply a hybrid approach to

entity theory, under which a partnership’s

net unrecognized section 987 gain or loss

with respect to its section 987 QBUs is

allocated to its partners on an annual basis

(the “hybrid approach to entity theory”), as

described in part VIII.D of this Explanation

of Provisions.

The hybrid approach to entity theory

may reduce concerns about inappropriate outcomes that might otherwise arise

from the transfer of partnership interests

under an entity theory approach. However,

as described in part VIII.D and E of this

Explanation of Provisions, while the

Treasury Department and the IRS study

whether the hybrid approach to entity theory (or a variation thereof) is suitable for

all partnerships, the proposed regulations

maintain the aggregate approach to section 987 aggregate partnerships in the final

regulations, as modified by the 2019 final

regulations, with minimal changes. Special

rules are provided in proposed §1.987-7C

for partnerships that become (or cease to

be) section 987 aggregate partnerships. In

addition, for consistency with other transfers of a section 987 QBU, the proposed

regulations would treat a change in the form

of ownership from direct to indirect as a

termination of the section 987 QBU under

proposed §1.987-8(b)(6), subject to the

deferral rules pursuant to proposed §1.98712(g)(1)(i)(A). The Treasury Department

and the IRS anticipate publishing a subsequent notice of proposed rulemaking that

more thoroughly addresses the application

of section 987 to partnerships.

D. The hybrid approach to entity theory

Under the proposed regulations, a

partnership (other than a section 987

Bulletin No. 2023–50

aggregate partnership) would be treated

as a qualified business unit having its own

functional currency. See §1.989(a)-1(b)

(2)(i)(C); see also §1.985-1(a)(1). If a

partnership owns an eligible QBU with a

functional currency that is different from

the functional currency of the partnership, the eligible QBU would be treated

as a section 987 QBU and the partnership

(and not the partner) would generally be

treated as the owner of the eligible QBU.

See proposed §§1.987-1(b)(4) through (5)

and 1.987-7A(b).

A partnership that owns a section 987

QBU would determine its unrecognized

section 987 gain or loss for a taxable year

under proposed §1.987-4(d) by reference

to the functional currency of the partnership and the section 987 QBU. Proposed

§1.987-7A(b). Under the hybrid approach,

the partnership would allocate to each

partner a share of the unrecognized section 987 gain or loss for the taxable year

with respect to each section 987 QBU

owned by the partnership on an annual

basis. The partnership would determine

a partner’s share of the unrecognized

section 987 gain or loss for the taxable

year for each section 987 QBU based on

the partner’s distributive share of profits

and losses attributable to that section 987

QBU for the taxable year. At the partner

level, each partner would translate its

share of the unrecognized section 987

gain or loss into its functional currency

at the yearly average exchange rate and

calculate its net unrecognized section 987

gain or loss with respect to each section

987 QBU of the partnership based on this

share. Proposed §1.987-7A(c)(1).

Section 987 gain or loss attributable to a section 987 QBU owned by a

partnership would be recognized and

taken into account at the partner level.

Notwithstanding that the section 987 gain

or loss pools are allocated to the partners

and maintained at the partner level, the

portion of the net unrecognized section

987 gain or loss that a partner would recognize (or suspend) each year under proposed §1.987-5(a) would be determined

by reference to the partnership’s remittance proportion with respect to the section 987 QBU. Proposed §1.987-7A(c)(3).

In other words, if the section 987 QBU is

treated as remitting 20 percent of its gross

assets to its owner, the partnership, in a

1405

taxable year of the partnership, each partner that has net unrecognized section 987

gain or loss with respect to the section 987

QBU would recognize (or suspend) 20

percent of the net unrecognized section

987 gain or loss.

The proposed regulations provide a

framework for adjusting a partner’s basis

in its partnership interest based on the

principles of section 705 when a partner

recognizes section 987 gain or loss, defers

section 987 gain or loss, or suspends section 987 loss attributable to a partnership.

See proposed §1.987-7A(d). Similarly,

if a partner in an upper-tier partnership

(UTP) recognizes section 987 gain or

loss, defers section 987 gain or loss, or

suspends section 987 loss attributable to

a lower-tier partnership (LTP), then the

proposed regulations would provide that

UTP makes a corresponding basis adjustment to its interest in LTP, with similar

rules applying to each successive partnership through which the section 987 gain

or loss is attributable. The basis adjustment between UTP and LTP or between

LTPs constitutes a basis adjustment solely

with respect to the partner that recognizes

section 987 gain or loss, defers section

987 gain or loss, or suspends section 987

loss attributable to the partnership. The

Treasury Department and the IRS request

comments on the coordination of these

proposed regulations applicable to partnerships with rules for capital accounts

determined and maintained in accordance

with §1.704-1(b)(2)(iv). Additionally, the

Treasury Department and the IRS request

comments on the appropriate currency in

which section 743(b) basis adjustments

with respect to assets of a section 987 QBU

of a partnership should be maintained.

The proposed regulations would also

provide rules for applying proposed

§§1.987-11 through 1.987-13 (regarding

deferred section 987 gain or loss and suspended section 987 loss) to partners and

partnerships. Specifically, the application

of the loss-to-the-extent-of-gain rule to

suspended section 987 loss of the partner is done at the partner level. Proposed

§1.987-7A(c)(4). As a result, any section

987 gain recognized by a partner is taken

into account in determining the suspended

section 987 loss that may be recognized by

the partner under proposed §1.987-11(e),

without regard to whether the section

December 11, 2023

987 gain was allocated to the partner

from that partnership (or any other partnership) or was attributable to a section

987 QBU owned directly by the partner.

Other rules under proposed §§1.987-11

through 1.987-13 would generally apply

with respect to a partnership, but may

be applied with respect to a partner that

ceases to be a partner in the partnership.

In general, the section 987 elections would be made by the partnership.

However, if a partner terminates its partnership interest, any annual recognition election in effect with respect to the

partner would apply with respect to its

deferred section 987 gain or loss or suspended section 987 loss that had been

allocated to the partner by the partnership.

The partner would also be permitted to

make the election to recognize pretransition section 987 gain or loss ratably over

the transition period under the transition

rules. See proposed §§1.987-7A(c)(5)(ii)

and 1.987-10(e)(5)(ii).

The Treasury Department and the IRS

are studying the appropriate method for

determining the portion of a partner’s net

unrecognized section 987 gain or loss,

deferred section 987 gain or loss, and

suspended section 987 loss that should

be recognized, deferred, or suspended

when a portion of a partner’s interest in

a partnership is transferred or redeemed

(or the partner’s interest in the partnership is otherwise reduced) and whether

any special rules are needed in respect of

a transfer or redemption of a partnership

interest to account for the recognition

of section 987 gain or loss at the partner

level. Accordingly, the proposed regulations reserve on the treatment of transfers

and redemptions of a partner’s partnership

interest. The Treasury Department and the

IRS request comments on the appropriate

method of determining the partner’s interest in the partnership and the reduction to

its interest in the partnership, as well as

how increases to a partner’s partnership

interest during the year should be taken

into account. In addition, the Treasury

Department and the IRS request comments on the appropriate treatment of

transfers of a partnership interest between

related parties or between member of a

consolidated group.

In general, proposed §1.987-6 would

provide rules governing the character and

December 11, 2023

source of section 987 gain or loss. See part

VI of this Explanation of Provisions. The

proposed regulations reserve on whether

any special rules are needed in addition to

proposed §1.987-6 for purposes of determining the character and source of section

987 gain or loss of a partner with respect

to a section 987 QBU owned by a partnership. Proposed §1.987-7A(e). Comments

are requested on whether special rules are

needed.

The proposed regulations would treat

S corporations in the same manner as

partnerships. Proposed §1.987-7A(f).

Comments are requested on whether additional guidance is needed with regard

to S corporations and whether there are

instances in which the rules for S corporations should differ from the rules for

partnerships.

The Treasury Department and the IRS

also request comments as to whether,

under an entity theory of partnerships,

section 987 gain or loss could be recognized at the partnership level and then

allocated to the partners while preventing

the transfer of unrecognized section 987

gain or loss among the partners or between

a transferor and transferee partner. Under

the hybrid approach in the proposed regulations, a partner’s recognition of section

987 gain or loss upon a sale or other disposition of a partnership interest results in

the conversion of capital gain or loss to

ordinary gain or loss without any remittance from the partnership QBU and without any change in the relationship between

the QBU and its owner. Comments are

requested on whether special rules are

needed to prevent the conversion of capital gain or loss to ordinary gain or loss.

In addition, comments are requested on

whether the recognition of section 987

gain or loss upon a transfer or redemption

of a partnership interest should be limited

to the gain or loss that would otherwise

be recognized on transfer or redemption,

under rules similar to §1.988-2(b)(8).

E. Expanding the application of entity

theory

The Treasury Department and the IRS

continue to study the application of entity

theory and aggregate theory to partnerships in the section 987 context, including whether it would be appropriate to

1406

apply a hybrid approach to entity theory

to all partnerships, regardless of whether

the partners are related parties. Such an

approach would generally result in a partnership generating the same amount of

section 987 gain or loss as it would if it

were a corporation or an individual.

In connection with these considerations, the Treasury Department and the

IRS are studying the concerns expressed

in the 2006 proposed regulations and the

final regulations that parties could achieve

a substantially different section 987 result

by owning a section 987 QBU through a

partnership, rather than owning the section 987 QBU directly, without meaningfully changing the economic relationship

of the parties.

Consider, for example, a domestic corporation that wholly owns two CFCs, each

of which use the euro as their functional

currency, and which each own fifty percent of an entity treated as a foreign partnership (“P”) that operates a British trade

or business for which books and records

are maintained in pounds. P also has a

smaller separate French trade or business

that is an eligible QBU that maintains

books and records in euros. If just one

CFC owned P, then P would be treated

as an entity disregarded from its owner,

and the CFC would have section 987 gain

or loss with respect to its interest in P’s

pound operations. However, if an election

was made to treat P as a corporation under

§301.7701-3, P would be treated as a CFC

that uses the pound as its functional currency and section 987 gain or loss with

respect to P’s euro operations would be

measured against the pound, rather than

against the functional currency of P’s

partners. Accordingly, it could be argued

that, for section 987 purposes, when a

partnership is held by CFCs, aggregate

theory achieves a result that is more akin

to treating P as a disregarded entity and

entity theory achieves a result more akin

to treating P as a corporation.

However, if instead of being owned by

two CFCs, P were owned by two domestic corporations that use the dollar as their

functional currency, aggregate theory

would achieve a result akin to treating P

as a disregarded entity, while entity theory may provide a means of allowing the

domestic corporations to avoid the application of section 987 to P’s pound trade or

Bulletin No. 2023–50

business without needing to contribute the

trade or business to a CFC, which might

have other tax consequences. See, e.g.,

section 367(a) and (d). Accordingly, the

Treasury Department and the IRS are concerned that if only entity theory is applied

to partnerships, there may be instances

in which the business of the partnership

should be subject to section 987 but is not,

such as when two domestic corporations

own a partnership doing business in the

pound.

When a partner’s functional currency

differs from that of the partnership, creating a separate layer of currency exposure,

the Treasury Department and the IRS are

studying whether it might be possible to

achieve a result consistent with aggregate

theory without the administrative burden

of allocating a portion of a partnership’s

assets and liabilities to each partner and

calculating the income and balance sheets

of the partnership in the functional currency of each partner. One such approach

might determine a partner’s section 987

gain or loss with respect to the partnership

by reference to the partner’s outside basis

in the partnership, rather than its share of

the inside asset basis and liabilities (the

“outside basis approach”).

The outside basis approach would be

layered on top of the hybrid approach to

entity theory taken by the proposed regulations. Under this system, a partnership

would first determine its section 987 gain

or loss with respect to any section 987

QBUs of the partnership, and allocate

the pool to the partners, as described in

§1.987-7A of the proposed regulations. If

a partner has the same functional currency

as the partnership, no additional steps are

taken.

If a partner has a different functional

currency than the partnership, under one

alternative (“alternative 1”), the partner would calculate its section 987 gain

or loss with respect to its interest in the

partnership (including its interest in the

functional currency trade or business of

the partnership and its interest in each of

the partnership’s section 987 QBUs) using

a method similar to the calculation of

unrecognized section 987 gain or loss for

an owner applying the current rate election under proposed §1.987-4(d) (that is,

steps 1 through 5 and 10), but by reference to the partner’s adjusted basis in its

Bulletin No. 2023–50

partnership interest (“outside basis”) in

the partnership.

Specifically, the partner’s annual section 987 gain or loss attributable to its

share of the partnership as a whole would

be equal to its outside basis determined

as of the end of the partnership’s taxable year (after taking into account other

adjustments prescribed under section 705

but before any adjustments for section 987

gain or loss recognized under the outside

basis approach) and translated into the

partnership’s functional currency reduced

by its outside basis determined as of the

beginning of the same partnership taxable

year and translated into the partnership’s

functional currency (the “partnership

functional currency change in value”)

(step 1). The partnership functional currency change in value would then be

adjusted to subtract the partnership functional currency amounts of contributions

to the partnership from the partner and

add the partnership functional currency

amounts of distributions from the partnership to the partner (steps 2 through 5).

The result would then be adjusted to back

out the partnership functional currency

amount of the partner’s allocable share of

income, gain, deduction, and loss of the

partnership (step 10). The result is the

partner’s unrecognized section 987 gain or

loss attributable to its partnership interest.

Under alternative 1, the partner’s unrecognized section 987 gain or loss attributable

to its partnership interest would be recognized annually and its basis in the partnership would be increased or decreased

accordingly. Alternative 1 approximates

the result a partner would achieve under

aggregate theory if it applied the current

rate election and the annual recognition

election.

Annual recognition is necessary under

alternative 1 to prevent differences in the

partnership’s adjusted bases in its assets

(“inside basis”) attributable to fluctuations

in the functional currency of the partnership itself or any section 987 QBUs

owned by the partnership and the partners’ outside bases (an “inside-outside

basis disparity”). By adjusting outside

basis for these currency fluctuations, the

partner’s section 987 gain or loss with

respect to the partnership will include section 987 gain or loss on the partnership’s

owner functional currency net value of

1407

the partnership’s section 987 QBUs. As a

result, the sum of the owner’s section 987

gain or loss attributable to its partnership

interest under the outside basis approach,

plus its allocable share of the partnership’s

net unrecognized section 987 gain or loss

attributable to the partnership’s section

987 QBUs should generally be equivalent

to the sum of its unrecognized section 987

gain or loss attributable to section 987

QBUs indirectly owned by the partner

through the partnership under the aggregate approach (assuming there are no

other inside-outside basis disparities).

Alternatively, under another alternative

(“alternative 2”), it may not be necessary

to require recognition of the partner’s

section 987 gain or loss annually. Under

this approach, the same method is used to

determine the partner’s section 987 gain or

loss with respect to its partnership interest

as in alternative 1, except that the partnership functional currency change in value

would be determined, not just by reference to the partner’s outside basis in the

partnership, but to the sum of its outside

basis and its net accumulated unrecognized section 987 gain or loss attributable

to the partnership and the partnership’s

section 987 QBUs (that is, the amount that

would have been recognized if the partner

had been recognizing its section 987 gain

and loss attributable to the partnership

annually as under alternative 1). Under

alternative 2, the partner’s unrecognized

section 987 gain or loss attributable to its

partnership interest might be recognized

when it receives a distribution from the

partnership or disposes of a portion of its

partnership interest.

Both alternative 1 and alternative 2

approximate the result a partner would

achieve under aggregate theory if it

applied the current rate election to its partnership interest. However, alternative 1,

but not alternative 2, requires annual recognition of the partner’s net unrecognized

section 987 gain or loss. Accordingly,

no additional loss limitations may be

needed for alternative 1. See part IV.C of

this Explanation of Provisions. However,

it may be appropriate for the partner’s

net accumulated unrecognized section

987 gain or loss under alternative 2 to

be subject to the loss-to-the-extent-ofgain rule in §1.987-11(e) of the proposed

regulations.

December 11, 2023

Under one variation to these alternative approaches, the partner’s net accumulated unrecognized section 987 gain or

loss attributable to its partnership interest

would net with the partner’s net unrecognized section 987 gain or loss with respect

to the partnership’s section 987 QBUs

when one amount reflects section 987 gain

and the other reflects section 987 loss.

Comments are requested on whether

the outside basis approach or a similar

system would achieve results consistent

with aggregate theory in a more administrable manner. Furthermore, comments

are requested on instances in which this

system might inappropriately diverge

from aggregate theory and how such

divergences might be addressed. For

example, if inside basis and outside basis

are not equivalent (for example, because

a partner acquires a partnership interest

in a year in which a section 754 election

is not in effect), how the resulting mismatch might be minimized or eliminated

for purposes of measuring the partner’s

currency exposure with respect to the

partnership. Comments are also requested

on whether the outside basis approach or a

similar system should apply to partners of

(i) all partnerships, (ii) only to those partnerships currently treated as section 987

aggregate partnerships, or (iii) only those

partnerships in which the partner owns

more than 50 percent of the partnership

interest (taking into account constructive

ownership).

In addition, comments are also

requested on any additional rules that

might be necessary to coordinate the outside basis approach or a similar system

with the section 987 regulations or with

subchapter K, when the functional currency of a partner, the partnership, and the

partnership’s section 987 QBU differ.

IX. Attribution of Items to the Section

987 QBU

The final regulations provide rules

regarding when assets and liabilities, as

well as items of income, gain, deduction,

and loss are attributable to an eligible

QBU, and when a section 987 QBU is

treated as making a contribution or distribution to its owner or another eligible

QBU of the owner. See §1.987-2. In general, the proposed regulations retain the

December 11, 2023

rules in the final regulations with minor or

clarifying revisions. However, in a change

from the final regulations, the proposed

regulations would treat a change in the

form of ownership of a section 987 QBU

as a termination, as discussed above.

In general, the final regulations provide

that items are attributable to an eligible

QBU if they are reflected on the separate set of books and records of the eligible QBU, as defined in §1.989(a)-1(d).

§1.987-2(b)(1). The proposed regulations

would revise the cross-reference to refer to

§1.989(a)-1(d)(1) or (2), as §1.989(a)-1(d)

(3) refers back to §1.987-2(b). Proposed

§1.987-2(b)(1).

In addition, the final regulations provide that an eligible QBU is not treated as

owning stock of a corporation unless the

owner of the eligible QBU owns less than

10 percent of the value of the corporation

(after taking into account certain attribution rules). §1.987-2(b)(2)(i). In order to

generally prevent an eligible QBU from

owning stock of a CFC, the proposed regulations would expand the exclusion to

cover all stock unless the owner owns less

10 percent of both the vote and value of

the corporation, and to revise the relevant

attribution rules. Proposed §1.987-2(b)(2)

(i). The proposed regulations also provide

that any type of basis that does not affect

the income and loss of the eligible QBU,

such as section 743(b) basis, would not

be treated as included on the books and

records of the eligible QBU. Proposed

§1.987-2(b)(5).

Similarly, the final regulations provide

rules regarding when a transaction or the

recording of an asset or liability as on (or

not on) the books and records of a section

987 QBU is treated as a disregarded transaction between the section 987 QBU and

its owner or another eligible QBU of the

owner. §1.987-2(c). The proposed regulations generally retain the substance of

these rules but make minor revisions for

clarity. See proposed §1.987-2(c).

years before the transition date generally

would not be taken into account under

section 987. In addition, for purposes of

applying the FEEP method in the first year

in which the regulations apply, the assets

and liabilities of the section 987 QBU

must be translated using historic rates.

Comments stated that the fresh start

transition method is difficult to apply

because taxpayers did not track historic

rates before the transition date and the

data needed to determine historic rates

for items acquired in prior taxable years

is not readily available. In addition, comments asserted that the fresh start transition method imposes an undue financial

burden by permanently eliminating unrecognized section 987 losses determined

before the transition date.

The Treasury Department and the IRS

acknowledge that the fresh start transition

method could increase the compliance

burden on taxpayers for the initial year

in which the regulations apply and would

fail to account for section 987 gain or loss

that arose before the transition date (to the

extent attributable to assets and liabilities

that are no longer reflected on the books

and records of the section 987 QBU on the

transition date). Therefore, the proposed

regulations provide a new transition rule

that would replace the fresh start transition method.

The new transition rule would account

for unrecognized section 987 gain or loss

accrued before the transition date. In

addition, the new transition rule would

not require taxpayers to retrospectively

determine historic rates for items acquired

before the transition date. As explained in

the Applicability Dates section, the fresh

start transition method can no longer be

applied to any taxable year for which the

tax return or information return is filed on

or after November 9, 2023.

X. Transition Rules

The transition rules under proposed

§1.987-10 would apply in the taxable year

beginning on the transition date (that is,

the first day of the first taxable year in

which the regulations apply). For purposes of determining unrecognized section 987 gain or loss in the first taxable

year in which the regulations apply, the

As explained in part II.C of the

Background section, the 2016 final regulations require all owners of section 987

QBUs to apply the fresh start transition

method. Under this method, unrecognized

section 987 gain or loss determined for

1408

A. Translation of a section 987 QBU’s

assets and liabilities at the spot rate

Bulletin No. 2023–50

assets and liabilities reflected on a section

987 QBU’s balance sheet at the end of the

previous year would be translated into the

owner’s functional currency at the spot

rate on the day before the transition date.

Proposed §1.987-10(d)(1). Similarly, for

taxpayers that do not make a current rate

election, the historic rate for historic assets

and liabilities would generally be the spot

rate on the day before the transition date.

Proposed §1.987-10(d)(2). These rules

are intended to simplify the application of

the FEEP method by eliminating the need

to determine actual historic rates in the

first taxable year in which the regulations

apply.

B. Pretransition gain or loss

Under the proposed regulations, an

owner of a section 987 QBU must determine the amount of section 987 gain or

loss that has accrued before the transition date (“pretransition gain or loss”).

Proposed §1.987-10(e). By default, in

the first taxable year in which the regulations apply, pretransition gain is treated

as net unrecognized section 987 gain, and

pretransition loss is treated as suspended

section 987 loss. Proposed §1.987-10(e)

(5)(i). This proposed rule is intended to

prevent taxpayers from selectively recognizing pretransition loss (which, like

section 987 loss generated under a current

rate election, may be computed using a

method that results in large section 987

pools) while deferring pretransition gain

until a remittance. Alternatively, taxpayers

can elect to amortize pretransition gain or

loss over a period of ten years beginning

on the transition date. Proposed §1.98710(e)(5)(ii).

In order to prevent owners subject to

this election from offshoring pretransition gain or importing pretransition loss,

proposed §1.987-10(e)(5)(ii)(B) provides

that, immediately before an inbound or

outbound transaction described in section

381(a), any unrecognized pretransition

gain is recognized and any unrecognized

pretransition loss is suspended. As a

result, the suspended section 987 loss may

be recognized, subject to the loss-to-theextent-of-gain-rule under §1.987-11(e).

In the case of an inbound section 381(a)

transaction of a foreign owner with pretransition loss, any suspended section

Bulletin No. 2023–50

987 loss that is not recognized before the

transaction would not carry over to the

domestic acquiring corporation under proposed §1.987-13(g). See part III.C of this

Explanation of Provisions.

C. Computation of pretransition gain or

loss

Under proposed §1.987-10(e)(2), a taxpayer that applied section 987 before the

transition date using an “eligible pretransition method” (described in part X.D of

this Explanation of Provisions) would use

that method to compute pretransition gain

or loss. Pretransition gain or loss generally

is equal to the amount of section 987 gain

or loss that would have been recognized

under the eligible pretransition method if

the QBU terminated on the day before the

transition date. Proposed §1.987-10(e)(2)

(i)(A). The amount of pretransition gain or

loss must be adjusted to reflect any change

to the basis of the section 987 QBU’s

assets (net of liabilities) that occurs as a

result of the transition (for example, where

the taxpayer previously used a method

that would determine the owner’s basis

in distributed assets using historic rates).

Proposed §1.987-10(e)(2)(i)(B).

A taxpayer that did not apply an eligible pretransition method before the transition date would determine pretransition

gain or loss using the method provided in

§1.987-10(e)(3). Under this method, pretransition gain or loss is equal to the sum

of the annual amounts of unrecognized

section 987 gain or loss for each taxable

year since the section 987 QBU’s inception, reduced by any section 987 gain or

loss recognized before the transition date.

Proposed §1.987-10(e)(3)(ii).

The amount of unrecognized section

987 gain or loss for each taxable year

would be computed using a simplified

version of the method provided in §1.9874(d). Proposed §1.987-10(e)(3)(iii). The

only information needed to apply this simplified method is the information reflected

in the section 987 QBU’s opening and

closing balance sheets for each year.

Because this method does not require the

translation of contributions and distributions at the applicable spot rate, it would

only approximate the actual amount of

section 987 gain or loss accrued before the

transition date.

1409

D. Eligible pretransition method

1. In General

An eligible pretransition method

includes any reasonable method of applying section 987 before the transition date

that fully accounts for foreign currency

gain or loss attributable to the assets and

liabilities of a section 987 QBU (including foreign currency gain or loss that is

recognized in computing taxable income

with respect to the section 987 QBU or

its owner). The method provided in the

1991 proposed regulations, which determines section 987 gain or loss based on

currency fluctuations with respect to the

earnings and capital of a section 987 QBU

(an “earnings and capital” method) is considered an eligible pretransition method,

provided that it is applied in a reasonable

manner. Proposed §1.987-10(e)(4)(i). In

addition, any other reasonable method of

applying section 987 is an eligible pretransition method if it produces the same

total amount of income over the life of the

owner (taking into account the aggregate

of section 987 gain or loss, section 987

taxable income or loss, and gain or loss

on the disposition of assets and liabilities transferred by a section 987 QBU to

the owner) as a reasonable earnings and

capital method. Proposed §1.987-10(e)(4)

(ii). However, a method under which the

owner does not recognize section 987 gain

or loss at the time of a remittance because

the recognition of all section 987 gain or

loss is deferred until the section 987 QBU

terminates is not considered an eligible

pretransition method because it is inconsistent with the statutory requirements

under section 987(3). Proposed §1.98710(e)(4)(iv).

2. Earnings Only Method

An earnings only method can qualify as an eligible pretransition method

under proposed §1.987-10(e)(4)(ii) if it is

applied in a way that produces the same

total amount of income as a reasonable

earnings and capital method. This can

be accomplished by maintaining a separate set of equity and basis pools for the

section 987 QBU’s capital account and

assigning a proportionate amount of the

capital basis pool to property distributed

December 11, 2023

out of capital. See proposed §1.987-10(l)

(2) (Example 2).

The Treasury Department and the IRS

are aware that certain taxpayers apply an

earnings only method in a manner that creates a permanent difference in their income

(as compared to the earnings and capital method). Under this approach, when

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.